If an investor or other third party looks at a company's cash position, more information is needed on how the company generated cash than merely looking at the starting and ending balances. The Statement of Cash Flows shows how we got from our beginning cash balance to our ending cash balance. Moreover, the Statement of Cash Flows can provide a shareholder with an insightful view of how a business produces its cash flow. It takes net income and reconciles it to net cash. This is achieved in three fields:
1. Operating Activities
2. Investing Activities
3. Financing Activities
Operating Activities
This portion of the SOCF analyzes non-cash expenses and revenues and changes the “operating” balance sheet Asset (Accounts Receivable, Inventory, Prepaid Expenses) and Liability (Accounts Payable, Accrued Liabilities, and Deferred Revenue) accounts.
Investing Activities
This section includes the “investments” the company made, such as Property Plant & Equipment purchases and sales, Payments made in connection with the acquisition of a business, and Purchases sales of marketable securities.
Financing Activities
This part of the Statement of Cash Flow covers: Sale or repurchase of company stock, Sale or repurchase of bonds, Borrowing, or repaying loans.
How to Prepare a Statement of Cash Flows?
There are two methods in which the Statement of Cash Flows can be prepared: the indirect method and the direct method. We will concentrate on the indirect method as this is the most common method to complete a cash flow statement.
We take net income under the indirect method and then analyze the balance sheet accounts to compute the change in cash during the period. We determine what happened to the asset account and what adjustment we need to make to net income to compute net cash from operating activities.
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