Analyzing Statements of Cash Flows I

The primary financial statements include the balance sheet, income statement, statement of cash flows, and statement of shareholders' equity. Each statement serves a specific purpose, providing insights into different aspects of a company's financial health.

The financial statements are interconnected. The income statement links two consecutive balance sheets by detailing the revenue and expenses incurred during the period between them. The cash flow statement adjusts the income statement items for non-cash transactions and changes in working capital, providing a link to the beginning and ending cash balances shown in the balance sheets.

The income statement and cash flow statement provide insights into changes in current assets and liabilities. Accruals and deferrals in these statements reflect the timing differences between the recognition of revenues and expenses and the actual cash movements, impacting the corresponding asset and liability accounts on the balance sheet.

This is calculated by adjusting the revenue reported on the income statement by the net change in accounts receivable. An increase in accounts receivable indicates that the cash received is less than the revenue reported.

This is determined by adjusting the cost of goods sold for the change in inventory and accounts payable. An increase in inventory suggests more purchases than the cost of goods sold, and an increase in accounts payable indicates less cash paid than the purchases recorded.

This is calculated by adjusting the salary and wage expenses by the net change in salary and wages payable. An increase in this payable account suggests that less cash was paid out than the expense recorded.

This involves adjusting other operating expenses by the net changes in prepaid expenses and accrued liabilities. Increases in prepaid expenses or accrued liabilities indicate adjustments to the cash basis to reflect actual cash outflow.

These are calculated by adjusting the respective expense by the net change in the corresponding payable account. For interest and taxes, an increase in the payable account indicates that less cash was paid than the expense recorded.

These are transactions that do not relate to the primary operations of the business, such as gains or losses from the sale of equipment. These are removed from net income in the operating section under the indirect method.

Expenses recorded on the income statement that do not involve cash outflow during the period, such as depreciation or amortization. These are added back to net income in the cash flow from operating activities.

Adjustments for changes in operating assets and liabilities that result from accrual accounting. Increases in operating assets are subtracted from, and decreases are added to, net income. Conversely, increases in operating liabilities are added to, and decreases are subtracted from, net income.

This involves disaggregating net income into total revenues and expenses, removing non-operating and non-cash items, and adjusting for changes in working capital to convert accrual-based figures to cash-based figures.

Begin by breaking down the net income into total revenues and total expenses. This step sets the foundation for further adjustments.

Non-operating gains and non-cash expenses such as depreciation are removed from the revenues and expenses to focus only on the operating cash flows.

Adjust the accrual basis revenues and expenses for changes in working capital accounts to convert them into cash basis receipts and payments.

This process involves adjusting the net income by removing non-cash revenues and expenses, and then adjusting for changes in working capital to reflect actual cash received or paid.

These are cash flows related to the acquisition and disposal of long-term assets and investments. Examples include cash paid for purchasing equipment and cash received from selling equipment.

Adjustments made to the cash flows to account for changes in working capital components such as accounts receivable, inventory, and accounts payable, which affect the cash flow from operations.

This involves determining the book value of the equipment sold (historical cost minus accumulated depreciation) and adjusting it by the gain or loss on the sale to find out the cash received.

Financing activities include transactions involving long-term liabilities and equity. Examples include cash inflows from issuing stock or debt and outflows from repurchasing stock or repaying debt.

Dividends paid can be calculated using the formula that relates beginning retained earnings, net income, and ending retained earnings. This calculation helps determine the cash outflow in the form of dividends.

There are notable differences in how cash flows are classified under IFRS and US GAAP, particularly concerning interest and dividends, which can be classified differently depending on the framework used.

Under US GAAP, interest and dividends received are classified as operating activities. IFRS allows these to be classified as either operating or investing activities. Similarly, interest paid is classified as an operating activity under US GAAP, while IFRS allows it to be classified as either operating or financing. Dividends paid are classified as financing activities under US GAAP, whereas IFRS permits classification as either operating or financing activities.

US GAAP mandates that all income tax expenses be classified as operating activities. IFRS also classifies them as operating activities by default, but allows for allocation to investing or financing activities if the tax expense can be specifically identified with those activities.

Under IFRS, bank overdrafts are considered part of cash equivalents and are included in the cash and cash equivalents balance. Under US GAAP, bank overdrafts are not considered part of cash and cash equivalents and are classified as financing activities.

Both IFRS and US GAAP allow the cash flow statement to be presented using either the direct or indirect method. However, if the indirect method is used, a reconciliation of net income to cash flow from operating activities must be provided.