Cash Flow Statements

Question 1

What is a cash flow statement?

Answer 1

Cash flow statements shows where cash is generated from and how it is used.

Question 2

What is the indirect method?

Answer 2

The indirect method begins with net income and adjusted for the following:

  i) non-cash and/or non-operating activities include included in net income 
      * depreciation and amortization
      * gains and losses on sale of assets
 ii) adjust for the impact of accruals and deferrals on net income
      * changes in current assets
      * changes in current liabilities

*The investing (non-current assets) and financing (non-current liabilities and equity) cash flow is calculated the same way for both indirect and direct method.

Question 3

What is the direct method?

Answer 3

The direct method of presenting the CFS presents the specific cash flows associated with items that affect cash flow. Items include:
     Cash collected from customers
     Interest and dividend received
     Cash paid to suppliers
     Cash paid to employees
     Interest paid 
     Income taxes paid 

*The investing (non-current assets) and financing (non-current liabilities and equity) cash flow is calculated the same way for both indirect and direct method.

Question 4

What is the rule of thumb for adding or decreasing CA and CL differences to operating cash flow?

Answer 4

Current Assets   Current liabilities
Increased	        Use(-)	         Source(+)
Decreased 	      Source(+)	             Use(-)

Question 5

Addition to or Deduction from cash:

i) Increased in A/R
ii) Decreased in A/R

Answer 5

i) Deduction from cash = Sales revenue was recognized but no cash was received.
ii) Addition to cash = customers on credit made cash payments.

Question 6

Addition to or Deduction from cash:

i) Increased in Inventory
ii) Decreased in Inventory

Answer 6

i) Deduction from cash = cash were used to purchase inventory.
ii) Addition to cash = Cash was generated from sales of inventory.

Question 7

Addition to or Deduction from cash:

i) Increased in A/P
ii) Decreased in A/P

Answer 7

i) Addition to cash = cash was received and entity owes an obligation.
ii) Deduction from cash = cash were paid out to satisfy an obligation.

Question 8

What items are included in cash collections from customers?

Answer 8

Sales
+/- Accounts Receivables
- Bad Debt Expense
+/- Changes in deferred revenue

Question 9

What items are included in cash paid to suppliers?

Answer 9

Cash paid to suppliers:
Cost of Goods Sold
\+ total operating expenses
\+/- Change in A/P
\+/- Change in accrued liabilities
\+/- Change in inventory
\+/-  Change in prepaid expenses 

• when deciding whether to +/- the changes, think of whether cash was paid out (add to expense account) to decrease the I/S account or increase in change (deduct from expense account) because cash was not involved.

Question 10

What balance sheet items goes into:

i) Operating activities
ii) Investing activities
iii) Financing activities

Answer 10

i) CA and CL
ii) non-current assets
iii) non-current liabilities and equity

Question 11

What items are involved in cash paid to employees?

Answer 11

Wages & Salaries Expense
+/- Change in wages payable

• when deciding whether to +/- the changes, think of whether cash was paid out (add to expense account) to decrease the I/S account or increase in change (deduct from expense account) because cash was not involved.

Question 12

What items are involved in cash paid for interest and bank charges?

Answer 12

Interest Expense
+/- Change in interest payable

• when deciding whether to +/- the changes, think of whether cash was paid out (add to expense account) to decrease the I/S account or increase in change (deduct from expense account) because cash was not involved.

Question 13

What items are involved in cash paid for income taxes?

Answer 13

Income tax expense
+/- change in income tax payable

• when deciding whether to +/- the changes, think of whether cash was paid out (add to expense account) to decrease the I/S account or increase in change (deduct from expense account) because cash was not involved.

Question 14

What are the advantages and disadvantage of the indirect method?

Answer 14

Advantages:

 * focuses on the difference between NI and net CF from operating activities
 * provide a useful link between CFS and I/S and B/S
 * simpler, therefore more cost effective to prepare

Indirect method is more common in practice.

Question 15

What are the advantages and disadvantage of the direct method?

Answer 15

Advantages:

• shows operating cash receipts and payment, which is more consistent with the objective of the CFS - to provide more info about cash receipts and cash payments
• sources of operating cash receipts and purpose of cash payments are useful in estimating future operating cash flows

Disadvantages:
*more costly

Direct method is theoretically superior and is recommended in the standards

Question 16

What are investing activities and what does it include?

Answer 16

Investing cash flows are monies expended and received from the purchase and sale of infrastructure necessary to run the business. Include the purchase and disposal of:

 * PPE
 * intangibles
 * Investments (gain or loss reported on the I/S does not represent cash received. The NBV + gains (- losses) is cash received)

Question 17

What are financing activities and what does it include?

Answer 17

Financing cash flows are monies expended and received with creditors and owners other than those of an operating nature. It include the following:

 * Dividend paid
 * Changes in demand loans
 * Changes in term loans
 * issue or redemption of share capital (common shares)

Question 18

Under investing activities, how is gains and losses on disposal of investments calculated?

Answer 18

Investments

Gain or loss reported on the I/S does not represent cash received. The NBV + gains (- losses) is cash received.

Question 19

Under the indirect method, what is net income adjusted for?

Answer 19

Non-cash expenses and revenue from non-operating activities such as gains on sale of investments/PPE if it was included in net income.

Notes: always consider if the amount was included in net income in the first place. If it was not included, then don’t need to adjust for it.

Question 20

What are operating activities?

Answer 20

Operating cash flows are those that arise from the normal, day-to-day operations of a business.

Question 21

Does direct method begin the CFS with net income?

Answer 21

No. Starts with Cash collections from customers.