The Statement of Cash Flows: Operating Activities Example (with video)

The Statement of Cash Flows

There are four financial statements that are used by investors for decision making: income statements, statement of retained earnings, balance sheet and statement of cash flows. The latter of these can be used by management in decision making for the business. The statement of cash flows shows where a businesses cash is going (cash outflows/use of cash) and what activities are creating cash inflows (source of cash) for the business.

The statement of cash flows is unmistakably the most difficult of the financial statements to prepare. With three sections, operating activities, investing activities, and financing activities, students often find this statement a bit challenging to master. Students first have to assimilate to the idea of accrual accounting where revenues are recorded when earned and expenses are recorded when incurred. When students finally have this topic concurred they are asked to complete the statement of cash flows that only represents cash inflows and outflows. Therefore, instead of taking balances from the ledger accounts (t-accounts) and placing them on a financial statement (i.e. balance sheet, income statement) we have to look at the changes in the account balances (i.e. change from beginning of the period to the ending of the period).

Creating the Operating Activities Section of the Statement of Cash Flows

Statement of Cash Flows - Example Operating Activities Section
There are three sections in the statement of cash flows: Operating activities, Investing activities, Financing activities. To remember the order of these sections on the statement of cash flows, I always remind myself... "Oh, I.F. I had more cash!"

In these three sections, the preparer of the statement of cash flows must analyze certain accounts on the income statement and the balance sheet.

Operating Activities - represents the cash flows from the day-to-day operations of the business (changes in current assets and current liability accounts; deprecation; gains; losses)

Investing Activities - reflects the cash flows from investing activities the business was involved in (changes in long-term assets accounts)

Financing Activities - reflects the cash flows from financing activities (changes in long-term liabilities and owners' equity accounts)

GAAP (Generally Accepted Accounting Principles) requires that the operating activities section of the statement of cash flows be created using the indirect method (i.e. adjusting net income back to the cash basis of accounting). Remember, under the accrual basis of accounting revenues are recorded when earned, not necessarily when cash is received (revenue recognition principle) and expenses are recorded when incurred, not necessarily when cash is paid (matching principle).

In the operating activities section, we analyze (calculate the change) all the current assets and current liabilities. In addition, we need to adjust net income for any non-cash expenses and gains and losses. A non-cash expense is an expense that is incurred but does not affect cash. For example, depreciation is the using up of a long-term assets that is expensed each accounting period and affectively reduces net income; however, this expense does not affect cash.

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