Explain the purpose and importance of cash flow information. The main purpose of the statement of cash flows is to report the major cash receipts and cash payments for a period. This includes identifying cash flows as relating to either operating, investing, or financing activities. Most business decisions involve evaluating activities that provide or use cash.

Distinguish between operating, investing, and financing activities. Operating activities include transactions and events that determine net income. Investing activities include transactions and events that mainly affect long-term assets. Financing activities include transactions and events that mainly affect long-term liabilities and equity.

Identify and disclose noncash investing and financing activities. Noncash investing and financing activities must be disclosed either in a note or a separate schedule to the statement of cash flows. Examples are the retirement of debt by issuing equity and the exchange of a note payable for plant assets.

Describe the format of the statement of cash flows. The statement of cash flows separates cash receipts and payments into operating, investing, or financing activities.

Analyze the statement of cash flows. To understand and predict cash flows, users stress identification of the sources and uses of cash flows by operating, investing, and financing activities. Emphasis is on operating cash flows since they derive from continuing operations.

Compute and apply the cash flow on total assets ratio. The cash flow on total assets ratio is defined as operating cash flows divided by average total assets. Analysis of current and past values for this ratio can reflect a company’s ability to yield regular and positive cash flows. It is also viewed as a measure of earnings quality.

Prepare a statement of cash flows. Preparation of a statement of cash flows involves five steps: (1) Compute the net increase or decrease in cash; (2) compute net cash provided (used) by operating activities (using either the direct or indirect method); (3) compute net cash provided (used) by investing activities; (4) compute net cash provided (used) by financing activities; and (5) report the beginning and ending cash balance and prove that it is explained by net cash flows. Noncash investing and financing activities are also disclosed.

Compute cash flows from operating activities using the indirect method. The indirect method for reporting net cash provided (used) by operating activities starts with net income and then adjusts it for three items: (1) changes in noncash current assets and current liabilities related to operating activities, (2) revenues and expenses not providing (using) cash, and (3) gains and losses from investing and financing activities.

Determine cash flows from both investing and financing activities. Cash flows from both investing and financing activities are determined by identifying the cash flow effects of transactions and events affecting each balance sheet account related to these activities. All cash flows from these activities are identified when we can explain changes in these accounts from the beginning to the end of the period.

Illustrate use of a spreadsheet to prepare a statement of cash flows. A spreadsheet is a useful tool in preparing a statement of cash flows. Six key steps (see appendix) are applied when using the spreadsheet to prepare the statement.

Compute cash flows from operating activities using the direct method. The direct method for reporting net cash provided (used) by operating activities lists major operating cash inflows less cash outflows to yield net cash inflow or outflow from operations.