How is a Cash Flow Statement Produced?

How is a Cash Flow Statement Produced?

Additionally, the cash flow statement may include disclosure of non-cash activities when prepared under generally accepted accounting principles (GAAP)-items like fixed asset depreciation, goodwill amortization and the like.

There are two methods of cash flow statement preparation: direct and indirect. The best choice for your business depends on how much detail you need to include in your statement, as well as how much time you are willing to dedicate. While both methods are GAAP-approved, the International Accounting Standards Board (IASB) prefers the direct reporting method. However, most small businesses use the indirect method.

Direct vs. Indirect Methods of Producing a Cash Flow Statement

The main difference between the direct method and the indirect method of presenting the statement of cash flows (SCF) involves the cash flows from operating activities. There are no differences in the cash flows from investing activities and the cash flows from financing activities under either method-the real difference lies in the operating activities.

  • Direct cash flow method: This method relies on cash-basis accounting. Finance records revenues and expenses as cash is received or disbursed by the business. The direct method requires more organization and legwork, since you subtract actual cash flows from inflows. Common line items using this method include customer receipts, payments to suppliers and employees, interest and dividends received and income tax payments.
  • Indirect cash flow method: This method is based on accrual-basis accounting, meaning revenue and expenses are counted when they are incurred rather than when money actually changes hands. Finance looks at the transactions recorded on the income statement and selectively reverses some of them to eliminate transactions that don’t show the movement of cash. This method also requires adjustments to add back any non-operating activities, such as depreciation, that don’t impact operating cash flow.

Accounts Receivable and Cash Flow

When it comes to the balance sheet, any changes in accounts receivable must be reflected in cash flow. A decrease in accounts receivable implies that more cash has entered the company from customers paying off credit accounts. The amount accounts receivable decreased is added to the company’s net sales. However, if accounts receivable increases, the amount of the increase must be deducted from net sales. That’s because, while accounts receivable amounts count as revenue, they are not cash.

Inventory Value and Cash Flow

When inventory increases, it indicates that a company has spent money on raw materials. If cash were used in the purchase of that inventory, the increase would be deducted from net sales. On the flip side, if there were a decrease in inventory, that would be added to net sales. If the inventory was purchased on credit instead of cash, the balance sheet would reflect an increase in accounts payable, and that year-over-year increase would be added to net sales.

Investing Activities and Cash Flow

Investing activities account for the income of a company’s investments. More specifically, these activities may include an asset purchase or sale, interest from loans or payments related to mergers and acquisitions.

Cash changes from making investments are payday loans Ohio considered use items, because cash is used on expenditures such as property, equipment or short-term assets. But when an asset is divested, that transaction is considered a source and is listed in cash from investing activities.

Cash From Financing Activities

Financing activities involve both cash inflows and outflows from creditors. This category comprises the money that comes from investors or banks, dividend payments, and goes out for stock repurchases and the repayment of loans.

Not all financing activities involve the use of cash, and only activities that impact cash are reported in the cash flow statement. Non-cash financing activities include the conversion of debt to common stock or issuing a bond payable to discharge the liability.

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