AFM 191 - Chp 10 - Cash flow statement Flashcards
which stakeholders care about cash flows?
both external + internal
why is it important for a business to have cash?
a business cannot operate if it runs out o cash + cannot meet the expectation of external stakeholders without sufficient cash to operate and grow the business
what’s the role of internal stakeholders for cash flows?
they must monitor cash flow to understand if and when the company needs to obtain additional cash from investors or banks - management monitors cash flows from operating activities and assesses if these cash flows are sufficient to cover investing and financing activities
when cash flows from operating activities are insufficient, financial activities take place.
what’s the importance of internal stakeholders understanding cash?
to forecast or predict future cash flows
what’s the use of cash flows for external stakeholders
to analyze cash flows ot determine a company’s continued ability to pay dividends and to assess whether a company is investing enough cash to fund future growth - e.g. banks analyze cash flows to assess whether the company will be able to make interest payments and repay its debt
why is cash important in start-ups?
to ensure that the company has sufficient cash to cover day-to-day operating activities and grow their business
what’s the importance of cash in mature private companies
cash is required to operate, repay debt, make investments, and pay dividends to owners
define operating activities
activities related to operating the core business
define investing activities
business activities related to purchasing or disposing of long-term assets and investments that are not cash equivalents or held for trading - activities related to making cash advances and loans to other parties are also investing activities
define financing activities
business activities related to raising capital
what are the following classifications in the cash flow statement in ASPE
- cash flows from interest paid and received which are included in net income should be classified as cash flows from operating activities
- cash flows from income taxes should be classified as cash flows from operating activities
- cash flows from dividends paid are charged to retained earning and should be classified as cash flows used in financing activities
what are the 2 ways to prepare a cash flow statement
- direct method
- indirect method
what information is required to prepare an indirect cash flow statement
- income statement for the period (to obtain net income, depreciation)
- statement of retained earning (to obtain dividends paid)
- balance sheet for the most recent and prior period (to adjust net income for non-cash working capital transactions and investing and financing activities)
- other financial information, as required
what’s the indirect method to calculate cash flow from/used in operating activities - define
a method used to calculate cash flows from/used in operating activities that uses accrual net income and adjusts it to determine operating cash flows
net income + non-cash items + changes in current assets + changes in current liabilities = cash flows from/used in operating activities
why do we use the indirect method?
this is the most widely used method in practice
what’s the relationship between the indirect method and accrual accounting/accrual net income
accrual net income does not consider when cash is received and/or disbursed
indirect method uses net income form the income statement as a starting point and adjusts it to determine cash flows from/used operating activities
what are the 3 main categories of adjustments that are made to net income and their adjustments
- non-cash items
a. add depreciation/amortization to net income
b. add losses on long-term asset disposals to net income
c. remove gains on long-term asset disposals from net income - changes in current assets (other than cash)
a. remove increases in current assets from net income
b. add decreases in current assets to net income - changes in current liabilities
a. add increases in current liabilities to net income
b. remove decreases in current liabilities from net income
why does net income need to be adjusted for non-cash items
these non-cash item impact net income but do not involve cash
how to adjust net income for cash flows for depreciation/amortization? why?
to increase net income by $Y to remove this non-cash transaction from net income when calculating cash flows from/for operating activities
we adjust it bc depreciation reduces net income as depreciation expense = debited but it does not involve cash
how to adjust net income for cash flows for gain/loss on long-term asset disposal? why?
net income is adjusted to remove the gain/loss when calculating cash flows from/used in operating activities
as gain/loss does not impact cash
what must companies do to understand the adjustments that need to be made to net income to add/remove changes in the non-cash operating working capital
companies must calculate the changes in the current assets and liabilities from the prior period
balance sheet for the most recent and prior period are required to calculate the changes in current assets and liabilities from 1 period to another
changes in current assets (other than cash) are adjusted on the net income for cash flows as:
- remove period-over-period increases in current assets from net income
- add period-over-period decreases in current assets to net income
why do we remove period-over-period increases in A/R to the net income for cash flows?
net income increases but this transaction does not involve cash, so if A/R increases, the increase is removed from net income when calculating operating cash flows
why do we add period-over-period decreases in A/R to the net income for cash flows?
this transaction does not impact net income but it does involve cash
if A/R decreases, the decrease is added to net income to calculate operating cash flows
why do we remove period-over-period increases in inventory to the net income for cash flows?
when inventory increases, Cash decrease - this transaction does not impact net income does it involves cash
if inventory increases, the increase is removed from net income when calculating operating cash flows
why do we add period-over-period decreases in inventory to the net income for cash flows?
when inventory decrease, COGS increases
this transaction decreases net income but it does not involve cash - if inventory decreases, the decrease is added to net income to calculate operating cash flows.
why do we remove period-over-period increases in prepaids to the net income for cash flows?
when prepaids increase, cash decreases
this transaction does not impact net income but it involves cash - if prepaids increase, the increase is removed from net income when calculating operating cash flows
why do we add period-over-period decreases in prepaid to the net income for cash flows?
when prepaid decrease, prepaid expense increase
this transaction deceases net income but it does not involve cash - if prepaid decrease, the decreases if added to net income to calculate operating cash flows
how are current liabilities adjusted on net income for cash flows;
- add period-over-period increases in current liabilities to net income
- remove period-over-period decreases in current liabilities from net income
why do we add period-over-period increases in A/P or accrued liabilities to the net income for cash flows?
when A/P increases, the company has incurs an expense but has not paid for it
this transaction decreases net income but it does not involve cash - if A/P increases, the increase is added to net income to calculate operating cash flows
why do we remove period-over-period decreases in A/P or accrued liabilities to the net income for cash flows?
when A/P decrease, the company paid back a supplier what it owed them
this transaction does not impact net income but it involves cash - if A/P decreases, the decrease is removed from net income to calculate operating cash flows
why do we add period-over-period increases in unearned revenue to the net income for cash flows?
when unearned revenue increases, a customer pays the company before the good/services are delivered
this transaction does not impact net income but it involves cash - so if unearned revenue increases the increases added to net income to calculate operating cash flows
why do we remove period-over-period decreases in unearned revenue to the net income for cash flows?
when unearned revenue decreases, revenue is recognized
this transaction increase net income but it does not involve cash - if unearned revenue decreases, the decrease is removed from net income to calculate operating cash flows
what’s the formula to calculate the cash flows from/used in operating activities
net income +/- non-cash items
+/- changes in current assets
+/- changes in current liabilities
in investing activities - what are some examples of cash inflows
cash is received from:
- disposing of a long-term asset
- sale of investments (excluding cash equivalents or investments held for trading)
- collection of advances and loans
in investing activities what are some examples of cash outflows
cash used in:
- purchasing new equipment or intangible asset
- purchasing a new store
- purchasing investments (excluding cash equivalents or investments held for trading)
- advances and loans made to other parties
what is needed to prepare cash flows from/used in investing activities
look at the period-over-period changes in the net book value of long-term assets
how to calculate the net book value of a long-term asset
beginning net book value of long-term assets + purchase of long-term assets - dispositions of used long-term assets - depreciation/amortization of long-term assets
repaying a loan is considered as a ______ activity
financing
interest payments are a part of of net income and ASPE considers these cash outflows part of ______ activities
operating
what happens when companies have more cash from operating activities than they need for investing activities
the company can decide to repurchase equity and/or pay dividends to shareholders
in financing activates what are some examples of cash inflows
cash received form
1. borrowing (bonds, loans)
2. issuing equity (selling company shares)
in financing activities - what are some examples of cash outflows
cash used in:
1. repaying debt (bonds, loans)
2. repurchasing equity (buying back shares)
3. paying dividends to shareholders
how to prepare cash flows from/used in financing activities
look at period-over-period change sin the balance sheet: current portion of long-term debt (current liabilities), changes in long-term liabilities and owner’s equity
look at the retained earning statement to determine if dividends were paid! (not declared) to shareholders
and additional info will be required such as amount of new loans, repayment of loans of bonds and amount of shares repurchased
define a bank statement
a document that includes all cash transaction that impacted the bank accounts during the month
does the ending balance in the bank statement always match the ending cash balance in the cash general ledger
no
every reporting period a company prepare a _____
bank reconciliation
define a bank reconciliation
a report that reconciles the bank statement with the ending cash in the general ledger
what are the 2 components to a bank reconciliation
- banks side (start with the bank statement balance)
- book side (start with the general ledger ending cash balance)
why is reconciliation between the bank and book side necessary
there are often cash items that are missing on both bank and book side
define the adjusted book balance
the correct cash balance after the bank reconciliations is complete
the adjusted book balance. should be ….
should be the same as the adjusted bank balance after the bank reconciliation is complete
on the bank side what are some items that require adjustments? do these adjusted require journal entries?
- deposits in transit - amounts added to bank side when preparing the bank reconciliation
- outstanding cheques - amount for cheques outstanding is deducted from the bank side
they do not require journal entries for these transaction as they have been recorded in the books but not included in the bank statement
define deposits in transit
cash deposits that have been reocreded in the general ledger but have not been processed by the bank yet
define outstanding cheques
cheques issued by the company (recorded in the books) but have not yet been cleared by the bank
what’s the starting point to adjustments on the bank side?
the ending cash balance on the bank statement
what’s the starting point to adjustments on the book side
the ending cash balance on the cash flow statement
what are some adjustments to items on the book side? do they require journal entries?
- bank collections - amounts are added to the book side
- ETFs (electronic funds transfers) -ETF receipts are added to the book side and ETF payments are deducted from the book side
- service charges - service charges are deducted from the book side
- interest income - interest income amounts are added to the book side
they require an adjusted journal entry bc it has not been recorded in the books - if an item is added to the book side, cash is debited and if an item is deducted from the book side, cash is credited
define bank collections
customers have paid for goods and services, the bank has reflected these transaction in is record but the company has not recorded the transaction yet
define ETF
the bank has processed payment to/from the company, but the company has not recorded the payment yet
define service charges
bank fees charged to the company that have not been recorded in the books
define interest income in the contest of book side - bank reconciliation
interest income earned by the company on certain savings accounts that have net been recorded in the books
this is not the same as interest income as interest earned on notes receivables or loans the company may issue to other parties
