The statement of cash flows explains where a company’s cash came from and how it was used during an accounting period. It complements the income statement because accrual accounting records revenues and expenses when they occur, not necessarily when cash changes hands.
A company can report a profit while having insufficient cash to pay its bills. Conversely, a company can report a net loss and still have cash available. These differences arise partly because revenues and expenses may be recorded in periods different from when the related cash is received or paid.
All flashcards
What is the purpose of the statement of cash flows?
It reports the sources and uses of cash during a period, helping users understand liquidity and cash generation beyond what net income alone reveals.
What are the three categories of cash flows?
Operating activities relate to day-to-day operations; investing activities relate to investments and long-term assets; financing activities relate to borrowing, equity, repayments, and distributions to owners.
How do the direct and indirect methods differ?
The direct method lists major cash receipts and payments. The indirect method starts with net income and adjusts it to arrive at operating cash flow.
Why is depreciation added back under the indirect method?
Depreciation reduces accounting income but is a noncash expense in the current period, so it is added back when reconciling net income to cash.
How does an increase in accounts payable generally affect operating cash flow?
It is generally added in the indirect-method reconciliation because expenses or purchases have been recorded but some related cash has not yet been paid.
Quiz questions
What does the statement of cash flows primarily show?Answer: The sources and uses of cash during an accounting period.
Why might a profitable company still have inadequate cash?Answer: Revenue and expenses may be recognized in periods different from related cash receipts and payments.
Which method begins the operating section with net income and adjusts it to operating cash flow?Answer: The indirect method.
Under the indirect method, why is depreciation added back to net income?Answer: It reduced net income but did not use cash in the current period.
A company’s accounts receivable increases during the year. How is this generally treated in the indirect operating section, and why?Answer: It is subtracted because some recorded revenue has not yet been collected in cash.
Based on Principles of Finance by Julie Dahlquist, Rainford Knight (OpenStax), licensed CC BY 4.0. Adapted into a summary, flashcards and quizzes.