Chapter_5_Working_Flashcards

Learning Objectives

• LO1: Understand and explain the significance of the statement of cash flows to users.

• LO2: Explain differences between the statement of cash flows and the statement of income.

• LO3: Identify three major types of activities in the cash flow statement and typical transactions for each.

• LO4: Prepare the statement of cash flows using the indirect method for operating activities.

• LO5: Prepare the statement of cash flows using the direct method for operating activities.

• LO6: Interpret the statement of cash flows and develop solutions for cash flow challenges.

• LO7: Calculate and interpret a company's operating cash flow ratio and net free cash flow.

Definition of Cash

• Cash: Includes cash on hand and demand deposits.

• Cash Equivalents: Highly liquid investments (e.g., money market funds, treasury bills) convertible into cash within three months.

Significance of the Statement of Cash Flows

Historical Perspective

• Assess the company's ability to generate cash from operations.

• Evaluate sources of cash (debt vs. equity).

• Assess capital asset investments.

• Determine cash used for debt repayment.

• Evaluate cash dividends distribution.

Predictive Basis

• Estimate company value based on future cash flows.

• Assess future debt repayment ability.

• Evaluate potential for future dividends.

• Estimate future cash needs and capital structure.

Cash Flow vs. Income

• The statement of cash flows uses a cash basis as opposed to the accrual basis of accounting.

• It includes all three categories: operating, investing, and financing activities.

Categories of the Statement of Cash Flows

• Operating Activities: Sales of goods/services, changes in current assets/liabilities, other business transactions.

• Investing Activities: Investment, sale, disposal of long-term assets (property, equipment, etc.).

• Financing Activities: Obtaining/repaying resources from shareholders and lenders (stocks, bonds, dividends).

Typical Cash Flow Transactions by Category

Operating Activities

• Inflows: Cash sales, collections from customers.

• Outflows: Inventory purchases, supplier payments, operating expenses, taxes, interest payments.

Investing Activities

• Inflows: Sale proceeds from property or shares.

• Outflows: Purchases of property or shares.

Financing Activities

• Inflows: Borrowing money, issuing shares.

• Outflows: Loan repayment, dividends.

Preparation of the Statement of Cash Flows

• Requires:

  • Comparative Statement of Financial Position.

  • Statement of Income for the current period.

  • Any additional relevant information.

Steps for Preparing Cash Flows – Indirect Method

1. Determine net change in cash (end - beginning balances).

2. Read additional information and cross-reference with the statement of financial position.

3. Adjust net income for non-cash items and non-operating activities.

4. Record net changes in cash for current assets and liabilities.

5. Record cash proceeds from sales or cost of asset purchases.

6. Record cash dividends paid.

7. Record cash from borrowing and shares issued.

8. Calculate total cash flows from all activities.

Direct vs. Indirect Methods

• The direct method categorizes receipts and payments explicitly.

• The indirect method links net income to cash flows from operating activities.

• Preference for the indirect method due to simplicity and available information.

Options for Classifying Cash Flows under IFRS

• Companies can classify cash flows related to interest paid/received and dividends paid/received in various ways but must maintain consistency.

Disclosures

• Activities that do not appear on the cash flow statement include asset purchases made via debt or shares, which should be disclosed in the notes.