Cash Flow Statement
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Introduction to the Cash Flow Statement |
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What Can the Statement of Cash Flows Tell Us? |
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Changes in Cash |
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Quizzes, word scrambles, crossword puzzles ... |
Introduction to Cash Flow Statement
The cash flow statement was previously known as the flow of Cash statement.The cash flow statement reflects a firm's liquidity.
The balance sheet is a snapshot of a firm's financial resources and obligations at a single point in time, and the income statement summarizes a firm's financial transactions over an interval of time. These two financial statements reflect the accrual basis accounting used by firms to match revenues with the expenses associated with generating those revenues. The cash flow statement includes only inflows and outflows of cash and cash equivalents; it excludes transactions that do not directly affect cash receipts and payments. These non-cash transactions include depreciation or write-offs on bad debts or credit losses to name a few. The cash flow statement is a cash basis report on three types of financial activities: operating activities, investing activities, and financing activities. Non-cash activities are usually reported in footnotes.
The cash flow statement is intended to
- provide information on a firm's liquidity and solvency and its ability to change cash flows in future circumstances
- provide additional information for evaluating changes in assets, liabilities and equity
- improve the comparability of different firms' operating performance by eliminating the effects of different accounting methods
- indicate the amount, timing and probability of future cash flows
The cash flow statement has been adopted as a standard financial statement because it eliminates allocations, which might be derived from different accounting methods, such as various timeframes for depreciating fixed assets.
The cash flow statement organizes and reports the cash generated and used in the following categories:
| 1. | Operating activities | – | converts the items reported on the income statement from the accrual basis of accounting to cash. |
| 2. | Investing activities | – | reports the purchase and sale of long-term investments and property, plant and equipment. |
| 3. | Financing activities | – | reports the issuance and repurchase of the company's own bonds and stock and the payment of dividends. |
| 4. | Supplemental information | – | reports the exchange of significant items that did not involve cash and reports the amount of income taxes paid and interest paid. |
What Can The Statement of Cash Flows Tell Us?
Because the income statement is prepared under the accrual basis of accounting, the revenues reported may not have been collected. Similarly, the expenses reported on the income statement might not have been paid. You could review the balance sheet changes to determine the facts, but the cash flow statement already has integrated all that information. As a result, savvy business people and investors utilize this important financial statement.
Here are a few ways the statement of cash flows is used.
- The cash from operating activities is compared to the company's net income. If the cash from operating activities is consistently greater than the net income, the company's net income or earnings are said to be of a "high quality". If the cash from operating activities is less than net income, a red flag is raised as to why the reported net income is not turning into cash.
- Some investors believe that "cash is king". The cash flow statement identifies the cash that is flowing in and out of the company. If a company is consistently generating more cash than it is using, the company will be able to increase its dividend, buy back some of its stock, reduce debt, or acquire another company. All of these are perceived to be good for stockholder value.
- Some financial models are based upon cash flow.
Understanding The Changes In Cash
To help you really understand the cash flow statement, we've put together some questions for you to answer. As you formulate your response you will be learning to think about cash flows the way an accountant does.
| 1. | When John Smith invests his personal money into her new company, what will happen to her company's Cash account? |
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| 2. | When a company purchases inventory (merchandise purchased in order to be resold) what will happen to its Cash account? |
Answer |
| 3. | What happens to the company's Cash account if it borrows money from the bank by signing a note payable? |
Answer |
| 4. | What happens to a company's Cash account if it declares a dividend on its shares of stock? |
Answer |
| 5. | What is the effect on its Cash account when a company pays some of its Accounts Payable ? |
Answer |
| 6. | What is the effect on its Cash account when a company prepays a 6-month insurance premium? |
Answer |
| 7. | What is the effect on its Cash account when a company sells merchandise, but allows the customer to pay in 30 days? |
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| 8. | What is the effect on its Cash account when a company receives payment from one of its customers 30 days after the sale was recorded? |
Answer |
| 9. | If a company's Accounts Payable account decreased, what is the likely effect this will have on Cash? |
Answer |
| 10. | If the asset account Prepaid Insurance increased, what is the likely effect on Cash? |
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| 11. | If the asset account Land increased, what's the likely effect on Cash? |
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| 12. | If the asset account Land decreased, what's the likely effect on Cash? |
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| 13. | If the liability account Bonds Payable increases, what is the likely effect on Cash? |
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| 14. | If the liability account Bonds Payable decreases, what is the likely effect on Cash? |
Answer |
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