I'm Larry Walford.
This is principlesofaccounting.com, Chapter 16.
This chapter is primarily about the statement of cash flows.
In this module, we're going to think about evaluating cash flows,
why there is a need for a statement of cash flows, and
some of the basic structure to the statement of cash flows.
Subsequent modules will go into the details of preparing and
presenting both the direct and
indirect approach, as well as a worksheet for preparing a statement of cash flows.
So, let's begin by considering that accounting is based upon accrual concepts.
Our income statement is an accrual based number.
We report revenues as earned, and
expenses as incurred, rather than when received and paid.
And we view that as a better performance measure indicator than
a cash-basis approach.
Accrual information is perhaps the best indicator of business success or failure.
However, one cannot ignore the importance of
cash flow information about a particular business.
A business may appear profitable on an accrual basis, but
they may be experiencing delays in collecting receivables, for example.
And in that case, a financial statement user would want to be wise to that,
in determine what is going on at the core of the business.
Now business may be experiencing significant growth.
And that can present its own cash flow challenges, even if profitable.
More money is needed.
More cash flow is needed to support new business locations, or
inventory expansions.
Things of that nature.
On the other hand, the business may be paying generous dividends.
And an investor may be pleased with that, unless they learn that to get the cash to
pay those dividends, perhaps they're disposing of significant long term
assets of the company that'll damage future performance prospects.
So there are things that can be signalled by a cash flow statement,
that are not apparent through an income statement alone.
So, the statement of cash flows is a required financial statement,
in addition to the balance sheet, and the income statement, and
the statement of retained earnings, or an expanded statement of stockholders equity.
In addition to those three core financial statements,
we are also going to be presenting a statement of cash flows.
It provides information that's useful in assessing the amount, timing,
and uncertainty of an organization's cash inflows and outflows.
There's three broad sections within the statement of cash flows.
These are the operating activities section, investing activities section, and
financing activities section.
So we're gonna show cash that is generated or expended in operations, and
then as well as cash that's generated or
expended from our investment activities and our financing activities.
We also have a category where we disclose information about significant
noncash investing and
financing transactions where we might be swapping one asset for another.
In the statement of cash flows, cash is usually cash and cash equivalents.
So it's a broad definition cash.
As a general rule, cash equivalents are short term,
highly liquid investments that mature in 90 days or less.
Turning to the operating activities, generally, these are activities that
are linked to transactions and events that enter into the determination of income.
The cash inflows from operating activities, I've enumerated several.
Receipts from customers for providing goods and services.
Cash received from interest and dividend income.
And the proceeds from the sale of trading securities.
Cash outflows consist of payments for
inventory, purchases of trading securities, employee salaries and
wages, taxes, interest and other normal business expenses.
Cash inflows from investing activities includes the sale of long-term stock and
bond investments, the disposal of long-term productive assets.
Receipt of principle repayments on loans made to others.
The reciprocal of those are cash outflows from investing activities relate
to payments made to acquire plant assets, or
other long-term investments in other firms, and loans made to other entities.
Cash inflows from financing activities includes proceeds received
when a company issues its own stock or bonds, borrowing under mortgage notes and
loans, cash outflows or repayments of amounts borrowed.
The acquisition of treasury stock, and importantly note that
dividends distributed to shareholders is a cash outflow from a financing activity.
So, do note that interest received, interest paid, and dividends received
are operating activities, but dividends paid is a financing outflow.
So the interest in dividends are debatable, shall we say?
But in the United States under US GAAP, there's a defined scheme for
classifying interest received, interest paid,
and dividends received in the operating activities section.
But dividends paid is considered to be financing.
Noncash investing and financing activities are those transactions that do not entail
the direct receipt of payment of cash, such as exchanging common stock for land.
Under US GAAP, the statement of cash flows includes a separate section for
noncash investing and financing activities.
Whereas under international accounting standards,
such information is presented in the notes to the financial statements.
So, this is a kind of brief overview of the major categories
of the statement of cash flows.
The next module we'll begin to look at the construction of that
statement of cash flow.