Assessing Cash Flow Statements
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Your accounting department has provided your team with the statement of cash flows prepared using the indirect method. At your first meeting, some of the managers have expressed concerns about the statement's understandability and do not view the statement as anything other than a "rearranged income statement". The managers have requested that your team explain to them how the statement is constructed. Explain the difference between the direct and indirect method. Also, explain to your managers why the indirect method is a useful approach to reporting cash flows from operating activities.
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Solution Summary
The solution explains what a cash flow statement is, its importance and why the indirect method is useful approach in computing cash flow from operating activities.
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Statement of Cash flow also known as Cash Flow Statement presents the movement of cash and cash equivalents in and out of the business over a period of time usually, accounting year. Cash and cash equivalents generally consists of Cash in hand, Cash at bank, Short term investments that are highly liquid and low risk. The primary reason this statement is prepared because Income Statement and Balance Sheet are prepared based on accruals basis of accounting. The non-cash items are removed to present the movement of cash inflows and outflows. In other words, the statement adjust the non-cash items from the income statement as well as balance sheet like depreciation, amortization, bad debt write off, accrued income/expenses etc. to arrive at net cash generated by the business. The cash flow statement reflects the business's liquidity and provides important insights about the solvency of a firm vital for its growth and survival.
Cash flow Statement summarizes the major changes in financial position during a accounting period and highlights priorities to the management. For example, increase in capital expenditure and research & development costs may indicate a rise in future sales whereas too many investment in short ...
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