16.7: Summary
- Page ID
- 10092
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\(\newcommand{\avec}{\mathbf a}\) \(\newcommand{\bvec}{\mathbf b}\) \(\newcommand{\cvec}{\mathbf c}\) \(\newcommand{\dvec}{\mathbf d}\) \(\newcommand{\dtil}{\widetilde{\mathbf d}}\) \(\newcommand{\evec}{\mathbf e}\) \(\newcommand{\fvec}{\mathbf f}\) \(\newcommand{\nvec}{\mathbf n}\) \(\newcommand{\pvec}{\mathbf p}\) \(\newcommand{\qvec}{\mathbf q}\) \(\newcommand{\svec}{\mathbf s}\) \(\newcommand{\tvec}{\mathbf t}\) \(\newcommand{\uvec}{\mathbf u}\) \(\newcommand{\vvec}{\mathbf v}\) \(\newcommand{\wvec}{\mathbf w}\) \(\newcommand{\xvec}{\mathbf x}\) \(\newcommand{\yvec}{\mathbf y}\) \(\newcommand{\zvec}{\mathbf z}\) \(\newcommand{\rvec}{\mathbf r}\) \(\newcommand{\mvec}{\mathbf m}\) \(\newcommand{\zerovec}{\mathbf 0}\) \(\newcommand{\onevec}{\mathbf 1}\) \(\newcommand{\real}{\mathbb R}\) \(\newcommand{\twovec}[2]{\left[\begin{array}{r}#1 \\ #2 \end{array}\right]}\) \(\newcommand{\ctwovec}[2]{\left[\begin{array}{c}#1 \\ #2 \end{array}\right]}\) \(\newcommand{\threevec}[3]{\left[\begin{array}{r}#1 \\ #2 \\ #3 \end{array}\right]}\) \(\newcommand{\cthreevec}[3]{\left[\begin{array}{c}#1 \\ #2 \\ #3 \end{array}\right]}\) \(\newcommand{\fourvec}[4]{\left[\begin{array}{r}#1 \\ #2 \\ #3 \\ #4 \end{array}\right]}\) \(\newcommand{\cfourvec}[4]{\left[\begin{array}{c}#1 \\ #2 \\ #3 \\ #4 \end{array}\right]}\) \(\newcommand{\fivevec}[5]{\left[\begin{array}{r}#1 \\ #2 \\ #3 \\ #4 \\ #5 \\ \end{array}\right]}\) \(\newcommand{\cfivevec}[5]{\left[\begin{array}{c}#1 \\ #2 \\ #3 \\ #4 \\ #5 \\ \end{array}\right]}\) \(\newcommand{\mattwo}[4]{\left[\begin{array}{rr}#1 \amp #2 \\ #3 \amp #4 \\ \end{array}\right]}\) \(\newcommand{\laspan}[1]{\text{Span}\{#1\}}\) \(\newcommand{\bcal}{\cal B}\) \(\newcommand{\ccal}{\cal C}\) \(\newcommand{\scal}{\cal S}\) \(\newcommand{\wcal}{\cal W}\) \(\newcommand{\ecal}{\cal E}\) \(\newcommand{\coords}[2]{\left\{#1\right\}_{#2}}\) \(\newcommand{\gray}[1]{\color{gray}{#1}}\) \(\newcommand{\lgray}[1]{\color{lightgray}{#1}}\) \(\newcommand{\rank}{\operatorname{rank}}\) \(\newcommand{\row}{\text{Row}}\) \(\newcommand{\col}{\text{Col}}\) \(\renewcommand{\row}{\text{Row}}\) \(\newcommand{\nul}{\text{Nul}}\) \(\newcommand{\var}{\text{Var}}\) \(\newcommand{\corr}{\text{corr}}\) \(\newcommand{\len}[1]{\left|#1\right|}\) \(\newcommand{\bbar}{\overline{\bvec}}\) \(\newcommand{\bhat}{\widehat{\bvec}}\) \(\newcommand{\bperp}{\bvec^\perp}\) \(\newcommand{\xhat}{\widehat{\xvec}}\) \(\newcommand{\vhat}{\widehat{\vvec}}\) \(\newcommand{\uhat}{\widehat{\uvec}}\) \(\newcommand{\what}{\widehat{\wvec}}\) \(\newcommand{\Sighat}{\widehat{\Sigma}}\) \(\newcommand{\lt}{<}\) \(\newcommand{\gt}{>}\) \(\newcommand{\amp}{&}\) \(\definecolor{fillinmathshade}{gray}{0.9}\)16.1 Explain the Purpose of the Statement of Cash Flows
- The statement of cash flows presents the sources and uses of cash.
- The statement of cash flows is used to predict future cash flows and to assess the quality of an entity’s earnings.
- There are two approaches utilized to prepare the statement of cash flow: the indirect method and the direct method.
16.2 Differentiate between Operating, Investing, and Financing Activities
- Transactions must be segregated into the three types of activities presented on the statement of cash flows: operating, investing, and financing.
- Operating cash flows arise from the normal operations of producing income, such as cash receipts from revenue and cash disbursements to pay for expenses.
- Investing cash flows arise from a company investing in or disposing of long-term assets.
- Financing cash flows arise from a company raising funds through debt or equity and repaying debt.
16.3 Prepare the Statement of Cash Flows Using the Indirect Method
- Preparing the operating section of statement of cash flows by the indirect method starts with net income from the income statement and adjusts for items that affect cash flows differently than they affect net income.
- Multiple levels of adjustments are required to reconcile accrual-based net income to cash flows from operating activities.
- The investing section of statement of cash flows relates to changes in long-term assets.
- The financing section of statement of cash flows relates to changes in long-term liabilities and changes in equity.
- Company activities that reflect changes in long-term assets, long-term liabilities, or equity, but have no cash impact, require special reporting treatment, as noncash investing and financing transactions.
16.4 Prepare the Completed Statement of Cash Flows Using the Indirect Method
- Preparing the operating section of statement of cash flows by the indirect method starts with net income from the income statement and adjusts for items that affect cash flows differently than they affect net income.
- Multiple levels of adjustments are required to reconcile accrual-based net income to cash flows from operating activities.
- The investing section of the statement of cash flows relates to changes in long-term assets.
- The financing section of statement of cash flows relates to changes in long-term liabilities and changes in equity.
- Company activities that reflect changes in long-term assets, long-term liabilities, or equity, but have no cash impact, require special reporting treatment, as noncash investing and financing transactions.
16.5 Use Information from the Statement of Cash Flows to Prepare Ratios to Assess Liquidity and Solvency
- Free cash flow relates to the amount of expected cash from operations which is left over after planned capital expenditures and dividends are paid.
- The cash flow to assets ratio correlates the company’s free cash flow to its total asset value.
- The cash flow to sales ratio considers free cash flow in relation to the company’s sales revenue.
16.6 Appendix: Prepare a Completed Statement of Cash Flows Using the Direct Method
- This section included an example of a statement of cash flows, prepared under the direct method, using the continuing example for Propensity Company.
- The direct method of preparing the statement of cash flows is identical to the indirect method except for the cash flows from the operating section.
- To complete the cash flows from operating activities, the direct method directly shows the cash collected from customers from revenue activities and the cash spent on operations, rather than reconciling net income to cash flows from operating activities as done using the indirect method. Calculating the amounts directly collected from revenues and spent on expenditures involves calculating the cash effect of the accrual amounts reported on the income statement.
Key Terms
- cash flow
- cash receipts and cash disbursements as a result of business activity
- direct method
- approach used to determine net cash flows from operating activities, whereby accrual basis revenue and expenses are converted to cash basis collections and payments
- financing activity
- cash business transaction reported on the statement of cash flows that obtains or retires financing
- free cash flow
- operating cash, reduced by expected capital expenditures and by cash dividends payments
- free cash flow to assets ratio
- ratio of free cash flow to total assets
- free cash flow to sales ratio
- ratio of free cash flow to sales revenue
- indirect method
- approach used to determine net cash flows from operating activities, starting with net income and adjusting for items that impact new income but do not require outlay of cash
- investing activity
- cash business transaction reported on the statement of cash flows from the acquisition or disposal of a long-term asset
- net cash flow
- method used to determine profitability by measuring the difference between an entity’s cash inflows and cash outflows
- noncash expense
- expense that reduces net income but is not associated with a cash flow; most common example is depreciation expense
- operating activity
- cash business transaction reported on the statement of cash flows that relates to ongoing day-to-day operations
- statement of cash flows
- financial statement listing the cash inflows and cash outflows for the business for a period of time