Question

Select TWO of the following topics to discuss:

1. Discuss the purposes of Statement of the Cash Flow, and what makes SCF different from other financial reports (e.g., Balance Sheet & Income Statement).

2. Discuss differences between Direct and Indirect methods to prepare a Statement of Cash Flow.

3. Discuss the Indirect method in more detail.

Answer 1

1)Purpose of Statement of Cash Flow(SCF) and how it differs from Income Statement and Balance Sheet  

The statement of cash flow is prepared to know the exact movement of cash and cash equivalents.In other words we can say, the main purpose of statement of cash flow is to provide more information about cash receipts and payments and the net change in cash in the operating ,investing and financial activities of an organization during the period.The statement helps interested parties determine if an entity needs external financing or if it is generating sufficient positive cash flow to meet its obligations and pay dividends

The main difference between cash flow statement and other financial reports is that cash flow statement deals only with cash items while other financial reports includes both cash and non cash items.When comparing CFS with income statement both shows companies performance over a period of time .Income statement shows the net profit /loss generated by the company while CFS shows how company have performed in managing inflows and outflows of cash.When comparing with balance sheet we know that balance sheet is the summary of the financial balances of a company to ascertain the financial position and it is prepared based on the information on a particular date ie in the year end.

The CFS how the changes in the balance sheet items and the income on the income statement impacts and affect the cash position.

2) Difference between Direct and Indirect Method

The indirect method is the most popular method of converting net income to net cash from operating activities. It starts with net income and then adjusts it back by adding back non cash expenses and paper losses and subtracting non cash revenue and paper gains that have no effect on current period operating cash flows. While in the case of direct method , net cash provided by operating activities is calculated by converting revenues and expenses from the accrual basis to cash basis.

Indirect method is also known as reconciliation method while direct method is also called income statement method.

3)Indirect Method

The indirect method is the most popular method of converting net income to net cash from operating activities. It starts with net income and then adjusts it back by adding back non cash expenses and paper losses and subtracting non cash revenue and paper gains that have no effect on current period operating cash flows.Additional adjustments are made for changes in current asset and liability acounts related to operations by adding or subtracting amounts.

Cash Flow from Operating Activities

Net Income

(+) Noncash Expenses

(-) Gains from investing and financing activities

(+) Losses from investing and financing activities

(+) Decreases in Current Assets

(-) Increases in Current Assets

(+) Increases in Current Liabilities

(-) Decreases inCurrent Liabilities

(+) Amortization of Discount on bonds

(-) Amortization of Premium on bonds

=Operating Cash Flow