Crash Course in Accounting and Financial Statement Analysis, Second Edition

Summary: Cash Flow from Operations

We have learned that while the income statement depicts a company’s revenues, expenses, and profitability arising from its daily operations, cash flow from operations attempts to capture cash movement associated with these daily activities. In order to arrive at cash flow from operations, we must convert the income statement from accrual accounting (by which it is prepared) to cash accounting (which governs the cash flow statement).

Accordingly, the first line of the cash flow statement of most companies is Net Income from the income statement, while the subsequent lines should be thought of as adjustments to net income, in order to arrive at the amount of cash generated from operations during the same period.

Common adjustments made in the cash flow from operations section include depreciation, changes in working capital (calculated as current assets less current liabilities), and changes in deferred taxes.

Any increase in assets must be funded and so represents a cash outflow:

• Increases in accounts receivable imply that fewer people paid in cash.

• Increases in inventories imply that they were purchased.

Any decrease in assets is a source of funding and so represents a cash inflow:

• Decreases in accounts receivable imply that cash has been collected.

• Decreases in inventories imply that they were sold.

Any increase in liabilities is a source of funding and so represents a cash inflow:

• Increases in accounts payable means a company purchased goods ...