Statement of Cash Flow Essay
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The importance of cash the cash flow statement help businesses and creditors understand how liquid a company is. Team A discussed some important factors about the statement of cash flow. The purpose of the statement of cash flow and how it is used in accounting is explained. The direct and indirect method of preparing a statement is used. Steps in preparation and classification are explained. The team also examines things that they struggled with and also things that they were comfortable with.
The purpose of the statement of cash flow
Statement of cash flows purpose is to provide information of cash payment, cash receipt of a business during a period. It also provides answer to question for future investors wanting to make investment in the company. The investors will looks at the business cash flow statement “where did the cash come from during the period, what was the cash used for during the period, what was the change in the cash balance during the period” (Kieso, Weygandt, Warfield, 2010, p.
198). This shows the business economic and solvency which is more attracted to the investors.
The statement of cash flow reports has four major categories, and they are 1) Cash effect of operating during a period. 2) Investing transactions transaction. 3) Financing transaction and 4) the net cash increase or decrease during the period. Between the four every aspect of a business transaction is covered. Statement of cash flow documents shows incoming and outgoing cash of the business. The document makes available a direction in which help guide decision of potential investor, reader, or lender understand the company financial report.
Because this document is prepared last it will show a company income statement, balance sheet, owner equity statement, as the result, the report adds validity and accountability to the company financial statements. For example, investors, analysts, potential investors, stockholders, and lender use the statement cash flow report to evaluate the financial strength of the business. How the statement of cash flow used in accounting A company will use the statement of cash flows to illustrate cash payments and receipt payments for a specific period.
This report shows how cash changes because of transactions that occur in daily operations such as investment transactions, financing transactions. This report will illustrate to investors and managers the level of liquid resources the company has available. Understanding a company’s cash flow will show the source of cash, the uses for the cash spent, and the balance of cash at the end of the period. This report will tie the information given on the income statement and on the balance sheet. The combination information provided in these statements provides a company’s inflows and outflows of cash.
The statement of cash flows removes transactions not related to cash events and allows a person to look at the areas within the business that generate cash or the areas that cause a loss of cash (Luft, 2012). Analyzing the statement of cash flow gives investors and managers a history of how the cash earned and how the cash was used along with the amount of cash remaining at the end of the month. The usefulness of the Statement of Cash Flow The usefulness of the statement of cash flow is for businesses to understand how they are dong financially.
Businesses use the statement of cash flow to know how quickly their assets can be converted into cash. Creditors are concern about how they will be paid. When a company can produce a high amount of cash, they can pay their bills. The statement of cash flow also provides information about a company’s spending habits. Because a company has net income does not mean their business thriving. Knowing the company’s net cash will provide the information needed to know whether or not to do business with them (Kieso, Weygandt, Warfield, 2010).
The inflow and out flow The statement of Cash Flow outlines the inflow and outflow of cash from a company for a given period. Inflows include the transfer of funds to a company from another party as a result of core operations, investments or financing (Nordmeyer, 2012). The inflow of cash is generated when businesses either sell their products or perform a service for revenue. Theses inflows can range from collections on accounts, monies from investors, or interest on loans. Cash outflow, on the other hand, is money leaving a company.
The outflow of cash from a company can include dividends paid to stockholders, bills, or the materials purchased to complete the products a company sells. Steps in preparation There are three major steps in preparing a Cash Flow Statement. The first step is to “determine the change in cash” (). This is calculated by comparing the current year’s cash balance to the previous year’s cash balance. For example, XYZ Inc. has a cash balance on its balance sheet of $100,000 and $90,000 for years ending December 31, 2011 and December 31, 2012 respectively.
Their change in cash would be a decrease of $10,000. The second step is to “determine the net cash flow from operating activities” (). This step is depends on the method chosen. The “direct method reports cash receipts and disbursements from operating activities” (). XYZ, Inc. reported the following: revenues of $80,000, accounts receivables $20,000, accounts payable $30,000 and operating expenses of $50,000. To calculate the net cash flow they would subtract accounts receivable from revenues ($80,000-$20,000 = $60,000) to determine cash collected from revenues.
Then, subtract accounts payable from operating expenses ($50,000-$30,000 = $20,000) to determine cash payments for expenses. Cash collected from revenues minus cash payments for expenses equals net cash provided by operating expenses ($40,000). This does not take into consideration income taxes. In contrast, the “indirect method adjusts net income for items that affected reported net income but did not affect cash. ” This is done by adding back noncash charges in the income statement to the net income and deducting noncash credits ().
Finally, the third step “determines the net cash flow from investing and financing activities. ” This step determines “whether any other changes in balance sheet accounts caused an increase or decrease in cash” (). This step could include changes in common stock, retained earnings, or bonds. The hardest part in grasping the cash flow steps was learning when to add or subtract an increase or decrease. However, through research I could learn an increase in accounts receivable, prepaid expenses, and how accounts payable is subtracted and a decrease is added (Investopedia, 2012).
Increases are added and decrease are subtracted for prepaid expenses and inventory (Investopedia, 2012). This week reflect on the statement of cash flow. Team A spoke about the importance of the statement of cash flow. It is need to determine where a company is financially. It is also use to understand the liquidity of a business. Why companies use the direct method or indirect method of preparing a statement is explained. Steps in preparation and classification are explained. The team also examines things that they struggled with and also things that they were comfortable with.