Module 4--Statement of Cash Flows and Shareholder's Equity

Question 1

What are the PURPOSES of the STATEMENT of CASHFLOWS?

Answer 1

Purposes of the Statement of Cash Flows
A company must be able to generate cash to survive. Net income is NOT equal to cash flow. The statement of cash flows (aka cash flow statement) explains the change during the period in cash and cash equivalents. The statement of cash flows, along with the balance sheet and the income statement, provides a comprehensive view of the company’s financial situation. The purposes of the statement of cash flows are to:

■ Assess the company’s ability to generate cash

■ Assess the company’s ability to meet financial obligations or pay dividends

■ Identify potential needs for additional financing

■ Identify the difference between net income and cash flows
* Statement of cash flows is prepared using cash accounting while the income statement uses
accrual accounting.
* A company may be profitable and still go bankrupt if cash flows are unable to meet current
liabilities as they become due.

■ Assess the effect of cash and noncash investing and financing transactions

Question 2

What are the TWO METHODS of REPORTING CASH FLOWS?

Answer 2

■ There are two methods of reporting cash flows.
* Direct method – procedure for recording all cash transactions, inflowsand outflows for the year

• Indirect method – procedure for adjusting net income for those items that do not affect cash flow from an accrual method to a cash basis

Question 3

What are the three categories the methods divide CASH FLOWS into?

Answer 3

■ Each method divides cash flows into three categories: operating, investing and financing. The only difference in the two methods is the operating section.