Cash Flows From Operating Activities PDF

Cash Flows from Operating Activities When using the indirect method, the statement of cash flows operating activities section begins with net income (or net loss) because revenues and expenses, which affect net income, produce cash receipts and cash payments. Revenues bring in cash receipts, and...

Cash Flows from Operating Activities When using the indirect method, the statement of cash flows operating activities section begins with net income (or net loss) because revenues and expenses, which affect net income, produce cash receipts and cash payments. Revenues bring in cash receipts, and expenses must be paid. But net income as shown on the income statement is accrual-based, and the cash flows (cash basis net income) do not always equal the accrual basis revenues and expenses. For example, sales on account generate revenues that increase net income, but the company has not yet collected cash from those sales. Accrued expenses decrease net income, but the company has not paid cash if the expenses are accrued. To go from net income to net cash flow from operating activities, we must make some adjustments to net income on the statement of cash flows. These additions and subtrac-tions follow net income and are labeled Adjustments to Reconcile Net Income to Net Cash Provided by Operating Activities. Depreciation, Depletion, and Amortization Expenses These adjustments include adding back non-cash expenses such as depreciation, depletion, and amortization expenses. These expenses are added back to net income to reconcile net income to net cash flow from operating activities. Let’s see why this occurs. Depreciation is recorded as followsYou can see that depreciation does not affect cash as there is no Cash account in the journal entry. Depreciation is a non-cash expense. The cash outflow related to depreciation occurred when the asset was purchased, not as it is depreciated. However, depreciation, like all the other expenses, decreases net income. Therefore, to go from net income to net cash flows, we must remove depreciation by adding it back to net income. Suppose you had only two transactions during the period: Cash sale of $60,000 Depreciation expense of $20,000 Accrual basis net income is $40,000 ($60,000 -$20,000), but net cash flow from operations is $60,000. To reconcile from net income, depreciation of $20,000 must be added to net income, $40,000, to determine net cash flow from operations, $60,000. We would also add back any depletion and amortization expenses because they are non-cash expenses, similar to depreciation. Gains and Losses from Non-operating Activities Gains and losses from non-operating activities, such as the disposal of long-term assets (investing activity), sale of investments (investing activity), or retirement of bonds (financ-ing activity), are included in net income. However, since these are non-operating activities, the gains and losses must be removed from net income on the statement of cash flows so the total cash receipts can be shown in the investing or financing sections. Exhibit F:14-4, ShopMart’s income statement, includes a gain on disposal of plant assets. During 2024, ShopMart sold equipment, and there was a gain of $10,000 on the sale. The gain was included in the calculation of net income on the income statement, so the gain must be removed from operating cash flows. The gain increased net income, so it is subtracted in the operating activities section. On the other hand, a loss on the disposal of plant assets would decrease net income on the income statement, so the amount of the loss would be reversed to determine the net cash provided by operating activities on the statement of cash flows. For example, a $5,000 loss on disposal of plant assets would be a $5,000 addition to net income on the statement of cash flows to determine net cash provided by operating activities. Changes in Current Assets and Current Liabilities Most current assets and current liabilities result from operating activities. For example: Accounts receivable result from sales. Merchandise inventory relates to cost of goods sold, and so on. Changes in the current asset and current liability accounts create adjustments to net income on the statement of cash flows, as follows: An increase in a current asset other than cash causes a decrease adjustment to net income. If Accounts Receivable, Merchandise Inventory, or Prepaid Expenses increases, then the adjustment to net income is a decrease. For example, ShopMart’s balance sheet in Exhibit F:14-3 shows that Accounts Receivable increased by $17,000. Accounts Receiv-able is increased when the company makes sales on account and decreases when the com-pany collects cash from customers. Therefore, there were more sales on account (revenue earned and reported on the income statement) than cash collections, the amount we want to reflect on the statement of cash flows. A decrease in a current liability causes a decrease adjustment to net income. Decreases in current liabilities have the opposite effect of increases. The payments of the current liabilities were more than the accrual of the expenses. Therefore, we sub-tract decreases in current liabilities from net income to get net cash flow from operating activities. ShopMart’s Accrued Liabilities decreased by $5,000. That change shows up as a $5,000 decrease adjustment to net income. Evaluating Cash Flows from Operating Activities During 2024, ShopMart’s operating activities provided a net cash inflow of $70,000 ($40,000 +$30,000), so the amount is labeled Net Cash Provided by Operating Activities. If this amount were a net cash outflow, ShopMart would report Net Cash Used for Operat-ing Activities The operating activities section (indirect method) always starts with accrual basis net income. Adjustments are then made to determine the cash basis net income. Exhibit F:14-6 summarizes the adjustments made to reconcile net income to net cash provided by operat-ing activities.