Businesses rely on the cash flow statement to help ensure they have enough cash on hand to pay their bills. Along with the income statement and the balance sheet, it is one of the “big three” financial reports. While the balance of the cash account is the ending point of the cash flow statement, non-cash assets and changes in asset account balances figure prominently within the statement. It’s essential to know how to account for assets in the cash flow statement in order to get correct results.
The balance sheet contains sections that list the asset, liability and equity accounts. The asset section divides into subsections for current and non-current assets. Current non-cash assets will convert to cash or expenses within 12 months. The balance sheet arranges them in order of descending liquidity, which is a measure of how easily an asset can convert to cash. Important current assets include cash and cash equivalents, accounts receivable, supplies, inventory and prepaid expenses such as rent and insurance. The non-current assets subsection includes fixed assets such as buildings, vehicles, plants, warehouses and equipment. It also includes investments and intangible assets, such as goodwill and patents.
The Cash Flow Statement
The format of the cash flow statement presents operating, investing and financial activities separately. Non-cash assets figure into the first two sections. Businesses that use accrual accounting use the indirect method to prepare the cash flow statement’s operations section, which requires adjustments to net income to account for changes in asset balances. Cash-method businesses prepare the cash flow statement using the direct method, in which an accountant reconciles changes to non-cash assets in the operations section with the net income reported on the income statement. The choice of direct or indirect method doesn't affect the financial and investing sections of the cash flow statement.
The operations section of the indirect cash flow statement begins with the net income reported on the income statement. The accountant then adjusts this amount for non-cash expenses, gains and losses on the sale of property, changes to non-cash current asset account balances and changes to certain liability accounts. Non-cash expenses include depreciation, amortization and provisions for bad debt, which the accountant adds back to net income. The accountant then adds back losses and subtracts gains on the sale of assets. Next, the accountant adjusts net income for changes to non-cash current assets by subtracting increases -- a use of cash -- and adding decreases, which are a source of cash. For example, a decline in accounts receivable represents a source of cash collections for the period. Finally, the accountant adjusts for changes in liabilities. The accountant applies the same procedures to reconcile the reported cash and cash equivalents on the direct cash flow statement with net income on the income statement.
Investment And Financing Activities
Investment activities that affect the cash balance include the sale and purchase of long-term assets and marketable securities. It also includes borrowing money and paying back loans. The accountant adds cash received from non-current asset sales and subtracts money spent on purchases of long-lived assets such as property, plant and equipment. For example, the accountant would subtract the cost for the purchase of a manufacturing plant. Financing activities that affect the cash flow statement generally don’t include non-cash assets, but rather items such as the issuance by the corporation of its bonds and stock or the payment of dividends. The grand tally of all adjustments to net income, when added to the beginning cash balance, should equal the balance in the cash account at the end of the period.
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