Statement of Cash Flow

Statement of Cash Flow

Firms use the statement of cash flow for information about the company's sources and uses of their cash. This is based upon the fact that a firm cannot generate cash and therefore cash cannot be accounted for in either the income statement or the balance sheet. The information that is used to provide the statement of cash flows is broken up into three components: 1) the balance sheet, 2) the income statement 3) selected transaction data which is information that describes how the cash was used during the period. There are three effects that are reported in the statement of cash flow to analyze cash. These include the firm's operating activities. investing activities, and financial activities. In the operating activities there are two different methods used in determining net cash flow: direct and indirect. All of these factors must be usued when developing a statement of cash flow.

Operating activities of a firm are used to indicate the capability of generating cash of the company. For example, cash receipts or cash payments made for maintaining production would be accounted for in the operating activities part of the statement of cash flow. In using the direct method or the income statement method, the cash receipts are deducted from the cash disbursements condensing the statement down. An example of this would be if we were to say that a tax company has reported revenue of $150,000. Because the accounts receivable increased to $40,000, only $110,000 of cash would be collected from the total revenue by taking $150,000-$40,000. By looking at the operating expenses, the company reported as $90,000 with accounts payable increased to $15,000. The cash for operating expense would be $90,000-$15,000 which would equal $75,000. The other method, the indirect or reconciliation method, deals with the net income for the items that are affected by reported income and not the ones affected by cash. In order to do this, the net income gets the noncash changes added back into it, and from there, deducts out the cash credits. When dealing with the accounts receivable, under accrual accounting, using the indirect method, it is important to note that as they increase within the year the goods sold are recorded as revenues, making revenues higher. If operations led to an increase in revenue, that may not all be in an increase in cash, so the accounts payable of $15,000 must be deducted from net income in order to convert the net income into net cash flow. When looking at an increase in accounts payable, expenses under accrual accounting are larger than cash based on the fact that the payment has yet to be paid. This means that the $15,000 in accounts payable must be added back into net income to convert it to net cash flow. When a company is new, it is rare that its operating activities will generate enough cash to meet its investing needs. Instead, they will be more likely to issue stock. Once a company has established itself, the operating activities tend to meet the cash needs.

Investing activities refer to the company's investments in property, plant, and equipment, which the cash from the operating activities does not show. Any increase or decrease in any of the three properties, plants, or equipment as well as any other cash inflow or outflow are accounted for in the investing activities portion of the statement. The third part of the cash flow statement refers to financing activities, which includes the issue of equity securities, increase or decrease in borrowing, purchases of common stock, as well as dividends. Companies have obligation to the investors to maintain dividends at current levels. One of the ways this is measured is by free cash flow which shows the cash that is available from operating activities after dividends are paid and capital expenditures are adjusted.

To give an example to better grasp this concept, let's suppose that Apple produced 20,000 Mac book Pros, which they then sold in just this year. The operating activities were reported $150,000 of cash provided. Apple invested $30,000 in the equipment for the Mac Books in order to keep the production stable for the 20,000 Mac Book Pros being produced. While they paid $10,000 in dividends their free cash flow formula would be the operating activities subtracted from equipment, which can also be capital expenditures, as well as dividends, making it look something like this; $150,000-$30,000-$10,000=$110,000 or the amount of gree cash flow Apple has left over to spend in a way to best suit the company. This can be anything from paying off debts, increasing the distribution of dividends, or buying new assets for expanding their business.

While the balance sheet and income statement are main components for accounting for a firm's income, inventory, and profit, the statement cash flows is the only statement able to generate the cash that the firm has. The operating, investing and financial activities are able to handle the firm's capabilities for cash in an organized manner. This statement is necessary for the businesses to keep track of their cash.

Article Source: http://www.articlesbase.com/business-articles/statement-of-cash-flow-3394801.html



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