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chapter 19.docx

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University of Calgary
ACCT 301

Chapter 19 Cash flow statements concentrate on the sources and uses of cash and are a useful indicator of a company’s liquidity and solvency. In other words it is about a page long and it summarizes the inflows and outflows of cash under specific sections. Most importantly though, a cash flow statement distinguishes between profit and cash. Why? Well, it has been argued that the figure for profit in the profit and loss account is misleading because it is calculated after numerous non-cash deductions or additions such as depreciation, profit on disposal of assets and accruals, whereas a cash flow statement simply says, let’s just discuss what the company paid or received in terms of cash only. To illustrate this further, suppose a company made a profit of 1 million pounds, does this necessarily mean that it has that amount of money in its bank account? As such, the survival of a business depends not so much on profits as on its ability to pay its debts when they fall due. Obviously a company’s net cash flow within a specific period may be measured by deducting the opening cash balance from the closing cash balance. However, would not one prefer to know the details of the transactions? Or what their effects are? Without disclosing much information, it is recommended that a cash flow statement summarizes the inflows and outflows of cash under the following categories: 1. Net Cash Flow from Operating Activities 2. Returns on Investments and Servicing of Finance 3. Taxation 4. Capital Expenditure and Financial Investment 5. Acquisitions and Disposals 6. Equity Dividends Paid 7. Cash Flow before Management of Liquid Resources and Financing 8. Management of Liquid Resources 9. Financing Okay, but what do these headlines mean, and where do we get the information to find the net cash flow for each of these categories? Operating Activities operating activities refer to the company’s trading activities and day-to-day operations, such as selling, distribution, administration expenses, etc. The cash flow statement attempts to summarize the net cash flow of these transactions, and this may be done in two distinct ways: 1. The Direct Method 2. The Indirect Method The direct method of calculating the net cash flow from operating activities is done in the following way: Cash received from customers Less: Cash paid to suppliers Cash paid to and on behalf of employees Equals: Cash flow from operating activities The indirect method calculates the net cash flow from operating a
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