Thursday, January 15, 2009

Understanding Cash Flow Statements

The Reading 34 turns out to be one of the greatest torture I have to go through. I took more than one and a half week on it. Partly because I had to work and hence could not have a continous study time of straight six hours but partly because the topic turns out to be deadly difficult. What is so difficult about cash flow right? Goodness, you cannnot imagine how accountants have invented horrible things probably just to make sure they keep their jobs! The Net Income to Operational Cash Flow reconciliation turns out to be non-trival. Familiarisation of accurals are extremely important. Determining how much cash the firm receives from sale of an equipment just examining the Income and Balance Sheet was not easy. But there are some standard formulaes that must be committed to the brain. Since my mind is fresh I'll type it here because I am sure these will become alien to me once again a few months down the road when I make my revisions:

Reconcile Net income to Operation Cash Flow:
+Net Income
- Depreciation Expense (because depreciation is recognised as an expense but there is no outflow of cash)
- Change in Accounts Receivable (because a positive change receivable means revenue but cash has yet to be collected from the customer)
+Change in Accounts Payable (because a positive change payable means expense was recognised but firm has yet to pay cash to suppliers)
- Change in Inventory (a positive change in inventory means cash is been paid to suppliers yet no expense is recognised)
= Cash Flow Due to Operations

Calculating Cash Received from sale of equipment:
First Step: Calculate Historical Cost of equipment sold -

Begin Equipment Historical Cost
+Equipment Purchase during the year
- Ending Equipment Historical Cost
= Historical Cost of equipment sold

Second Step: Calculate depreciation value of equipment sold -

Begin Accumulated depreciation
+Depreciation expense for the year
-ending Accumulated depreciation
= depreciation value of equipment sold

Third Step: Calculate cash received from equipment sold-
Book Cost of equipement sold = Historical Cost of equipment sold -depreciation value of equipment sold
Plus Gain (loss)
= cash received from equipment sold

Calculating cash paid to suppliers, customers, employees, and "other operating expenses", income taxes must be commtited to the brain cells.

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