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Cash Flow Statement Part 2 Notes

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Cash Flow Statements - Part 2

Upon completion of this lesson you will be able to prepare statement of cash flows for an entity using indirect method and further study the investing and financing activities in detail. Definition A cash flow statement shows the change in cash and cash equivalents of a company under the category of operating, investing and financing activities. Cash and cash equivalents include cash in hand, bank, short-term liquid investments (bonds, securities) that are freely switch into cash. In other words Cash flow statement also known as statement of cash flows evaluates the change in cash and cash equivalents during a period, it classifies the cash inflows and outflows in operating, investing and financing activities so that it can be analyzed clearly from which type of activity cash is flowing inwards and outwards, the format of cash flow statement is given later in these notes. Any Items will not be included in cash flow statement that does not involve cash for e.g. depreciation expense. These are known as Non cash activities. Why is it important?
The cash flow statement is considered necessary because the accounting profit figures are easy to manipulate. There are many items in the income statement involving judgment such as depreciation, allowance for bad debts etc. This makes it difficult to interpret a company's performance with confidence. A statement of cash flows showing cash inflows and outflows is easier to understand and difficult to manipulate. Lecture Notes In the earlier lesson we study that direct method of presentation is recommended for cash flows from operating activities, but the indirect method can also be used. Here we will look at the indirect method to compute operating cash flows. Again it is important to note that the net cash flows from any of the method (direct or indirect) will be the same. The recommended format for operating cash flows (indirect method) is as follows:

The operating cash flows of the cash flow statement (Indirect Method)

add: add: less: add: less:

Net Profit/ EBIT


xxx Non-Cash Expenses: (Depreciation, Amortization Expense) Non-Operating Losses: (Loss on disposal of long lived Assets) Non-Operating Gains: (Gain on disposal of long lived Assets) Decrease in Current Assets: (A/c Receivable, Prepaid Expenses, Inventory etc.) Increase in Current Assets


xxx *

xxx add:

Increase in Current Liabilities: (A/c Payable, Accrued Liabilities, Tax Payable etc.)


Decrease in Current Liabilities





(xxx) xxx (xxx) xxx


Net cash flow from Operating activities

The Indirect method used above: begins with net profit/ EBIT adjusts for non-cash items adjusts for increase or decrease in working capital Example: Indirect Method:



Net Income/ EBIT 7,000 Depreciation Expense 1,000 Increase in Accounts Receivable 4,400 Increase in Prepaid Rent 7,000 Decrease in Prepaid Insurance 1,300 Increase in Accounts Payable 14,000 Increase in Wages Payable 1,000 Decrease in Income Tax Payable 700 Gain on Sale of Equipment 1,800 Solution: Cash Flow from Operating Activities:


Net Income/ EBIT add: Depreciation Expense less: Gain on Sale of Equipment

7,000 1,000 (1,800)



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