Depreciation
Information about cash flows can influence decision makers in many ways . For
example , if a company’s regular operations bring in more cash than it uses ,
investors will value the company higher than if property and equipment must be
sold to finance operations . Information about cash flow can help creditors
decide whether a company will have enough cash to pay its debts as they mature.

Management and investors use cash flow information to evaluate a company’s
ability to meet unexpected obligations . Cash flow information is also used to
evaluate company’s ability to take advantage of new business opportunities
that may arise. In November 1987, the FASB issued Statement of Financial

Accounting Standards "statement of cash flow " This standard requires
businesses to include a statement of cash flow in all financial reports that
contain both a balance sheet and an income statement. The primary purpose of
this statement is to present information about a company’s cash receipts and
disbursements during the reporting period. Direct Method of Presenting Cash Flow
from Operating Activities When you prepare a statement of cash flow , the net
cash provided by operating activities can be calculated two different ways . One
is called Direct Method the other is Indirect Method .When the direct method is
used , you separately list each major class of operating cash receipts and each
major class of cash payments . Then the payments are subtracted from the
receipts to determine the net cash provided by operating activities. The FASB
encourage companies to use direct method. Indirect Method of Presenting Cash

Flow from Operating Activities The indirect method is not as informative as
direct method because it does not disclose the individual cash inflows and
outflows from operating activities. Instead the direct method discloses only the
net cash provided by operating activities . When the indirect method is used ,
the net income is listed first . Then it is adjusted for items that are
necessary to reconcile net income to the net cash provided by operating
activities . For example , you know that depreciation expense is subtracted in
the calculation of net income . But , depreciation expense does not involve a
current cash payment. Therefore, depreciation expense is added back to net
income in the process of reconciling net income to the net cash provided by
operating activities. Cash and Cash Equivalents In Statement of Financial

Accounting Standards , the FASB concluded that a statement of cash flow should
explain the difference between the beginning and the ending balances of cash and
cash equivalents. Prior to this new standard ,cash equivalents were generally
understood to be short term , temporary investments of cash . However , not all
short-term investments meet the FASB definition of cash equivalents . To qualify
as a cash equivalent , an investment must satisfy two criteria . These are: 1-

The investments must be readily convertible to a known amount of cash. 2- The
investments must be sufficiently close to its maturity date so that its market
value is relatively insensitive to interest rate changes. Classifying Cash

Transactions A statement of cash flow describes the changes in cash plus cash
equivalents. Therefore, cash payments to purchase cash equivalents and cash
receipts from selling cash equivalents are not reported on the statement. All
other cash receipts and payments are classified as operating , investing or
financing activities. Within each category , individual cash receipts and
payments are summarized and described in a manner that clearly presents the
general nature of the company’s cash transactions . Then , the summarized cash
receipts and payments within each category are netted against each other . A
category provides a net cash flow if the receipts in the category exceed the
payments . And if the payments in a category exceed the receipts , the category
is a net user of cash during the period. Operating Activities You should
recognize the operating activities generally include only transactions that
relate to the calculation of net income . However, some income statement items
are not related to the operating activities . As disclosed in a statement of
cash flows , operating activities involve the production or purchase of
merchandise and the sale of goods and services to customers . Operating
activities also include the expenditures related to administering the business.

In fact , cash flow from operating activities include all cash flows from
transactions that are not defined as investing or financing activities . Cash

Flows from Operating Activities Cash Inflows Cash Outflows -Cash sales to
customers -Payments to employees for salaries and -Cash collections from credit
customers wages -Receipts of