Guidance on Preparing Cash Flow Statement - Indirect Method

School: University of Phoenix - Course: ACCOUNTING /290 - Subject: Accounting

Guidance in Preparing a Cash Flow Statement- Indirect method © 2022 Pedago, LLC. All rights reserved.6/23/211History of the Cashflow Statement: The balance sheet and income statements have been around for years and report activity under accrual accounting requirements. It was not until 1988, that the accounting standards required a cashflow statement to be included as one of the primary financial statements for all companies to present. It communicates to stakeholders the company's cash activity during a designated time frame, for example, for the year, quarter, or month. Cash is important which is why the cashflow statement is a key part of any analysis. (FASB STATEMENT NO. 95) There are two methods for preparing the cashflow statement, the direct and indirect method. The indirect is the easiest and hence is the method most chosen. Using the indirect method in preparing the cashflow statement means you begin with the company's net income which is based on accrual accounting. We then add and subtract various activities to convert accrual net income into three categories, (operating, investing, and financing), to inform readers of the amount of cash inflows and outflows for each. Since depreciation expense is a "non-cash" transaction, (recall we debit Depreciation expense and credit Accumulated Depreciation) and since it was deducted to get to net income, we need to add it back in order to eliminate it. After the adjustments like depreciation, we then begin with looking at changes in the balances, from the beginning of the time period (Quarter, Year, etc.) to the end of the time period, for assets and liabilities. The general rule is an increase in an asset would be a decrease in cash and an increase in a liability would be an increase in cash. Presented below are the steps in preparing a cashflow statement:

Guidance in Preparing a Cash Flow Statement- Indirect method © 2022 Pedago, LLC. All rights reserved.6/23/212OperatingSectionInvestingSectionFinancing Section 1 2 2.A. Adjustments (non-cash): Depreciation expense, Amortization, Depletion, Loss of Sale of Assets ✚ Gain on Sale of Assets ⎯ 2.B. Current Assets(i.e. Inventory, Accounts Receivable, Prepaid Expenses) : Change in the balance for the year is an Increase ⎯ Change in the balance for the year is a decrease ✚ 2.C. Current Liabilities(i.e. Accounts Payable, Salaries Payable) : Change in the balance for the year is an Increase ✚ Change in the balance for the year is a decrease ⎯ Sum of 1 & 2 3 Long-Term Assets(i.e. PP&E, Investments) : Change in the balance for the year is an Increase ⎯ Change in the balance for the year is a decrease ✚ Note: Increase in investments from earnings such as dividend, interest, and capital gains income ✚ Sum of 3 4 Short Term and Long Term Debt(i.e. Loans Payable, Notes Payable, Bonds Payable) : Change in the balance for the year is an Increase ✚ Change in the balance for the year is a decrease ⎯ Equity(i.e. PIC, Common Stock, Preferred Stock) : Change in the balance for the year is an Increase ✚ Change in the balance for the year is a decrease ⎯ Note: Cash Dividends paid out ⎯ Treasury Stock : Change in the balance for the year is an Increase ⎯ Change in the balance for the year is a decrease ✚ Sum of 4 5 6 Sum 5 & 6 Key Cash Inflow Add✚ Cash Outflow (Subtract)⎯ Total Change in Cash (sum the operating, financing, and investing section totals) Beginning Cash Balance ( Report the cash balance that the company began with for the applicable time frame. For example, if the cash flow statement is presenting the company's business year activities, look to the balance sheet for the cash amount that the company ended with in the prior year. Remember, the balance sheet accounts are permanent accounts and the amount that a company ends with in one year will be the starting balance for day one of the following year.) Ending Cash Balance ( The amount reported here should agree to the cash amount reflected on the balance sheet for the same period ending.)