Depreciation Essays - Cash Flow, Financial Statements,

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