Ch5text - CHAPTER 5 THE CASH FLOW STATEMENT Up to this...

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CHAPTER 5 THE CASH FLOW STATEMENT Up to this point we have focused almost exclusively on the balance sheet, the income statement, and the statement of retained earnings, as well as the mechanics of dealing with balance sheet and income statement accounts. The fourth and last major financial statement is the cash flow statement. It augments the other statements, especially the income statement, by explaining how the cash account changed during a certain period of time. This chapter introduces the cash flow statement and the mechanics of its preparation. The statement contains information useful to readers of financial reports because it indicates the firm’s ability to generate cash through its operations and by other means and it also shows how the firm is spending its cash. After reading and studying this chapter, you should be able to: Indicate the purpose of the cash flow statement; State the components of the cash flow statement; Explain changes in cash in terms of operating, investing, and financing activities; Reconcile revenues with cash received from revenue activities and expenses with cash expenditures; Employ the T-account method to determine cash flow from operating, investing, and financing activities; Use the worksheet method to measure cash flow from operating, investing, and financing activities; and Prepare a statement of cash flows using either the indirect or direct method for calculating operating cash flows.
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Ketz--Cash Flow Statement Page 5-2 PURPOSE OF THE CASH FLOW STATEMENT The cash flow statement explains the change in cash in terms of cash flows from the operating, investing, and financing activities of the firm. While the cash flow statement has been required only since 1987 (FASB’s Statement of Financial Accounting Standards No. 95), it is a very important financial statement because it helps investors and creditors in understanding the liquidity and the solvency of the firm. Liquidity is the ability to generate cash and solvency refers to the ability to pay debts as they come due. If the firm is unable to pay its liabilities, then it becomes subject to various penalties such as higher interest rates, extra charges in terms of late fees, and—at the limit—corporate bankruptcy. Since investors and creditors can lose some or all of their money if a bankruptcy materializes, they want advance warning of the likelihood of a firm’s inability to pay off its debts. One source of information is the cash flow statement. Another purpose of the statement deals with quality of earnings. As the student should know, the determination of accounting earnings involves a number of estimates (such as the life of an asset being depreciated) and a choice among various accounting conventions. When investors analyze the income statement of a corporation, they want to know how the number was computed. Did the managers employ conservative methods and estimates (e.g., short lives for depreciation) or did they make aggressive
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This note was uploaded on 01/26/2011 for the course HRIM 318 taught by Professor Howard,paul during the Fall '10 term at Pennsylvania State University, University Park.

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Ch5text - CHAPTER 5 THE CASH FLOW STATEMENT Up to this...

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