2022 Curriculum CFA Program Level I Financial Reporting and Analysis Show
IntroductionThe cash flow statement provides information about a company’s cash receipts and cash payments during an accounting period. The cash-based information provided by the cash flow statement contrasts with the accrual-based information from the income statement. For example, the income statement reflects revenues when earned rather than when cash is collected; in contrast, the cash flow statement reflects cash receipts when collected as opposed to when the revenue was earned. A reconciliation between reported income and cash flows from operating activities provides useful information about when, whether, and how a company is able to generate cash from its operating activities. Although income is an important measure of the results of a company’s activities, cash flow is also essential. As an extreme illustration, a hypothetical company that makes all sales on account, without regard to whether it will ever collect its accounts receivable, would report healthy sales on its income statement and might well report significant income; however, with zero cash inflow, the company would not survive. The cash flow statement also provides a reconciliation of the beginning and ending cash on the balance sheet. In addition to information about cash generated (or, alternatively, cash used) in operating activities, the cash flow statement provides information about cash provided (or used) in a company’s investing and financing activities. This information allows the analyst to answer such questions as:
Answers to these questions are important because, in theory, generating cash from operations can continue indefinitely, but generating cash from selling assets, for example, is possible only as long as there are assets to sell. Similarly, generating cash from debt financing is possible only as long as lenders are willing to lend, and the lending decision depends on expectations that the company will ultimately have adequate cash to repay its obligations. In summary, information about the sources and uses of cash helps creditors, investors, and other statement users evaluate the company’s liquidity, solvency, and financial flexibility. This reading explains how cash flow activities are reflected in a company’s cash flow statement. The reading is organized as follows. Section 2 describes the components and format of the cash flow statement, including the classification of cash flows under International Financial Reporting Standards (IFRS) and US generally accepted accounting principles (GAAP) and the direct and indirect formats for presenting the cash flow statement. Section 3 discusses the linkages of the cash flow statement with the income statement and balance sheet and the steps in the preparation of the cash flow statement. Section 4 demonstrates the analysis of cash flow statements, including the conversion of an indirect cash flow statement to the direct method and how to use common-size cash flow analysis, free cash flow measures, and cash flow ratios used in security analysis. A summary of the key points and practice problems in the CFA Institute multiple-choice format conclude the reading. Learning OutcomesThe member should be able to:
SummaryThe cash flow statement provides important information about a company’s cash receipts and cash payments during an accounting period as well as information about a company’s operating, investing, and financing activities. Although the income statement provides a measure of a company’s success, cash and cash flow are also vital to a company’s long-term success. Information on the sources and uses of cash helps creditors, investors, and other statement users evaluate the company’s liquidity, solvency, and financial flexibility. Key concepts are as follows:
What's the difference between the statement of cash flows and the beginning and ending cash on the balance sheet?While the cash flow statement shows cash coming in and going out, the balance sheet shows the assets and liabilities that result, in part, from the activities on the cash flow statement.
What does a statement of cash flow show?The purpose of a cash flow statement is to provide a detailed picture of what happened to a business's cash during a specified period, known as the accounting period. It demonstrates an organization's ability to operate in the short and long term, based on how much cash is flowing into and out of the business.
Which of the following statement about the statement of cash flows is not correct?It reconciles ending cash balance with the balance as per bank statement is incorrect about the statement of cash flows.
Which statement is true about the statement of cash flows?Answer and Explanation: The correct option is (d) Investing activities in the statement of cash flows include acquiring and selling long-term assets. We show the cash flows related to long-term assets and investments under the cash flows under financing activities in the cash flow statement.
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