Overview

This topic covers how to prepare and analyze the Statement of Cash Flows using the indirect method. You'll also learn about financial ratios used to assess liquidity, solvency, and operational efficiency.

Key Concepts and Categories

• Statement of Cash Flows: Reports changes in cash from operating, investing, and financing activities.
• Indirect Method (Operating Section): Starts with net income and adjusts for non-cash expenses and changes in current assets/liabilities.
• Investing Activities: Purchases/sales of long-term assets (e.g., equipment, investments)
• Financing Activities: Borrowing and repaying debt, issuing stock, paying dividends
• Noncash Transactions: Must be disclosed separately (e.g., acquiring land by issuing stock)
• Liquidity Ratios:
  • Current Ratio = Current Assets / Current Liabilities
  • Quick Ratio = (Current Assets - Inventory) / Current Liabilities
• Solvency Ratios:
  • Debt-to-Equity = Total Liabilities / Total Equity
  • Interest Coverage = EBIT / Interest Expense
• Activity Ratios:
  • Inventory Turnover = COGS / Average Inventory
  • Accounts Receivable Turnover = Net Credit Sales / Avg. A/R

Step-by-Step Example

Problem: A company has net income of $50,000. Depreciation expense is $6,000. Accounts receivable increased by $3,000. What is net cash provided by operating activities?

Step 1: Start with net income: $50,000

Step 2: Add back non-cash expense: + $6,000

Step 3: Subtract increase in A/R: – $3,000

Answer: Net cash provided = $53,000

Quick Tip