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 on credit, conserving its cash.

Any decrease in liabilities is a use of funding and so represents a cash outflow:

• Decreases in accounts payable imply that a company has paid back what it owes to suppliers.

1. Cash Flow from Operating Activities

Exercise Q1: Which of these line items typically show up in a reconciliation from net income to cash flow from operations on the cash flow statement? Depreciation and amortization Purchase of fixed assets Deferred taxes Changes in accounts receivable

2. Cash Flow from Operating Activities

Exercise Q1: Which of the following operating activities have a positive cash flow impact for a company? Increase in accounts receivable Decrease in accounts receivable Increase in inventories Increase in accounts payable

3. Cash Flow from Operating Activities

Exercise Q1: Which of the following operating activities have a negative cash flow impact for a company? Decrease in inventories Increase in inventories Increase in deferred tax liabilities Increase in other current assets

1. Cash Flow from Operating Activities

Solution Q1: Which of these line items typically show up in a reconciliation from net income to cash flow from operations on the cash flow statement? Depreciation and amortization Purchase of fixed assets Deferred taxes Changes in accounts receivable

2. Cash Flow from Operating Activities

Solution Q1: Which of the following operating activities have a positive cash flow impact for a company? Increase in accounts receivable Decrease in accounts receivable Increase in inventories Increase in accounts payable

3. Cash Flow from Operating Activities

Solution Q1: Which of the following operating activities have a negative cash flow impact for a company? Decrease in inventories Increase in inventories Increase in deferred tax liabilities Increase in other current assets