respond to the response below: Hello everyone! Taking from the reading of Miller-Nobles' book, the statement of
Question:
respond to the response below:
Hello everyone!
Taking from the reading of Miller-Nobles' book, the statement of cash flow comes as a complement to the statement of balance sheet and the income statement to illustrate with detail the cash behavior during a business period. In that sense, the cash flow statement focuses on activities (operating, investing, and financing) performed during a specific business period.
In that case, there are some positive and negative consequences affecting differently both net income and the cash flow statement. I will evoque two events that can affect both net income and cash flow.
For example, when a company sells some of its inventory on credit, and the customers agree to pay later, there is revenue that the company recognizes in its income statement, but no cash is received. Therefore, it will be a positive net income with a negative impact on the cash flow since the cash is not yet collected.
It will be the same whenever the company pays its suppliers for inventory purchased in advance. In this case, there are cash outflows, but nothing was received. These cash outflows will negatively affect the cash flow, not the net income.
Since most companies use accrual-based accounting, the positivity and the negativity impact either net income or cash flow statements depending on cash transactional activities.
A company that has been operating negatively in cash flow for three years has a high risk of going into bankruptcy if it does not quickly find a way to collect its receivables from its customers. It also means that the managers have been making bad decisions regarding operating activities, which put the company short in cash to repay its creditors and find financing resources to renew its assets or expand its business.
Under the indirect method, depreciation, depletion, and amortization expenses are added to net income in the operating activities section of the cash flow statement to come up with the net cash from the operation activities. It is to adjust the amount of net income by adding back the amount of those expenses.
The company may improve its cash flow by avoiding advance payment to suppliers if possible, by encouraging advance collection from customers with respect to the clause of contracts, and thirdly encouraging the reduction of dividend distribution by stockholders.
Fundamentals of Corporate Finance
ISBN: 978-1259024962
6th Canadian edition
Authors: Richard Brealey, Stewart Myers, Alan Marcus, Devashis Mitra, Elizabeth Maynes, William Lim