BUS103: Introduction to Financial Accounting

10a. Distinguish the types of business transactions that are included in operating, investing, and financing activities 

• What business activities fall under the operating sections of the cash flow statement?
• What business activities fall under the investing section of the cash flow statement?
• What business activities fall under the financing section of the cash flow statement?
  

Inflows and outflows of cash are reported in three different sections of the statement of cash flows. Operating activities are those transactions and events that enter into the calculation of net income. Investing activities are transactions and events that involve the purchase and sale of securities and property, plant and equipment. Financing activities are transactions and events involving equity and debt financing.
 
List the cash inflows and cash outflows for each of the following sections of the statement of cash flows: operating activities, investing activities, and financing activities.

You will find examples of the cash inflows and outflows included within each category in Operating Activities, Financing Activities, and Investing Activities.

10b. Summarize the difference between the indirect and direct methods of preparing the statement of cash flows

• How is the operating activities section prepared using the indirect method?
• How is the operating activities section prepared using the direct method?

There are two methods of preparing a statement of cash flows: direct and indirect. The investing and financing sections are unaffected by the method utilized, but the operating activities section will vary depending on the method used.
 
The direct method analyzes all the operating expenses to determine what cash was actually spent in the period and only counts cash sales. The indirect method starts with accrual-based net income and then adjusts it for items that affected net income but did not involve cash.
 
To review, see Calculating Cash Flows.

10c. Prepare a cash flow statement

• What is the check figure when preparing a cash flow statement?
• What are the steps required to prepare a cash flow statement?

When preparing a cash flow statement, the answer is known before you begin the work: the difference between the cash account at the beginning of the period and the end is the next change in cash that your cash flow statement will need to tie to. Even though the "answer" is known, preparing the statement helps the financial analyst understand how the cash was generated and used in the course of business.
 
The steps to prepare a cash flow statement are:
 

1. Calculate the change in cash for the period.
2. Using the indirect method, convert the accrual-based net income to cash basis by:
   1. adding back any non-cash items on the income statement
   2. adjusting the current asset and current liability accounts for changes in cash
   3. adjusting gains and losses
3. Analyze cash flow effects of investing activities
4. Analyze cash flow effects of financing activities
5. Total all sections and balance to change in cash for the period (#1 above)

To review, see Cash Flow Statement.
 

Unit 10 Vocabulary

This vocabulary list includes terms you will need to know to successfully complete the final exam.

• direct method
• financing activities
• indirect method
• investing activities
• operating activities