The Cash Flow Statement
The Income Statement is not a measure of cash because it is calculated on an accural basis rather than a cash basis. In the accural system, income is recorded when it is earned and expenses when incurred, whether or not the money it has actually been received or paid. In contrast, in the cash-basis system, income and expenses are recorded when cash is received or paid.
Numbers reported through each of these systems will defer because, for example, in the Income Statement:
- sales include both cash sales and credit sales;
- expenses include purchases not yet paid as suppliers offered them in credit;
- depreciation is not a cash movement;
- frequently not all income tax is paid within the reported period;
- among other differences.
The Cash Flow Statement measures the firm’s cash inflows and outflows. The cash flow statement comes from data in the Income Statement and in the Balance Sheets from the beginning and end of the accounting period.
Cash Flow from Operations
- Start with the operating income from the Income Statement
- Add back depreciation expense as it is not a cash movement
- Subtract income tax (we’ll dealt with it later)
- Adjust Working Capital (receivables / payables / inventories) from the Balance Sheet differences in year 1 and year 2 (depending whether they are source or use of cash)
Cash Flow from Investing Activities
When fixed assets are purchased or sold, cash flows that occur are not shown in the Income Statement. Based on the gross change between the fixed assets between the BS in year 1 and 2, we can determine the if the company got cash or used cash for fix asset investing activities.
Cash Flow from Financing Activities
These activities include inflows and outflows coming from i) paying dividends and interests ii) increasing or decreasing of short-term and long-term debts and iii) issuing and repurchasing of shares. These calculations are also done by subtracting BS items of Y1 to BS in Y2.
Tags: accural system, cash flow statement, cash inflow and outflow