NON CASH ACTIVITIES

What business activities are considered non-cash activities? In order to prepare a cash flow statement, we need to understand which items on our income statement and balance sheet may not involve the transfer of cash, thus will not have a place on our statement of cash flows.

These non-cash activities may include depreciation and amortization, as well as obsolescence. Property, plant and equipment resides on the balance sheet. These items are taken on the income statement in small increments called depreciation or amortization.

If we purchase a new dump truck, we don't take the entire purchase price as an expense when we purchase it. We put it as an asset on our balance sheet, and then take depreciation expense over the life of the dump truck.

These non-cash items need to be properly recorded on the income statement but disregarded for the cash flow statement.

Cash and cash equivalents are those items on the balance sheet that are liquid assets. Cash can be spent, so it is the most liquid of the assets.

Cash equivalents might include money market accounts, treasury bills or commercial paper. It is essentially a place to sit money, to make a return on it. Cash sitting in a checking account may get no interest, but a money market account will earn interest while it sits. In this way, a company can put its idle cash to work.

These cash equivalents are pretty easy to move to a checking account if the cash becomes needed, but getting interest rather than just letting it sit there is a smart step!

Operating Activities

You have been asked to figure out cash flow for your company. Luckily, your supervisor has only asked you to do the operating activities section! But what items are included here? As you look through the income statement and balance sheet, what stuff do you need to be looking for? Also, what the heck is coming in (inflows) and going out (outflows)? Let's watch a video and then tackle the operating activities portion of our cash flow statement.

There are several sections that comprise the cash flow statement. The first portion of the cash flow statement includes what are called operating activities. These are cash transactions that happen in the normal course of business, affecting the revenue and expense accounts on your income statement. Operating activities can include the following items:

Collecting cash is the only cash inflow here! The other items all involve cash leaving your business, also called outflows. So from now on, money coming in will be called an inflow and money going out will be called an outflow.

This portion of the cash flow statement can help you to better understand the need to have an effective accounts receivable system! If you sell product, but can't collect the cash in a timely fashion, it may become difficult to meet your bill payment deadlines. If you don't pay your bills on time, vendors, your employees and the government (especially the government) might not be happy with you.

In our budgeting module, we put together a cash budget. A cash budget is an important component of the financial health of all companies. Having enough cash coming in from customers and clients to cover the cash going out to meet payment responsibilities is crucial to successfully running or managing a business.

Investing Activities

The second section of the cash flow statement involves investing activities. We will again be chatting about inflows and outflows as it relates to investments.

Watch this video to get an explanation of the investing activities part of the cash flow statement:

What happens when we buy an asset? Let's say we buy a truck for our business. As we discussed earlier, we put the purchase price of the truck as an asset on our balance sheet, then we take small amounts as an expense each month as depreciation to spread the expense out over time. If we purchased the truck for $25,000, from a cash perspective, we had a $25,000 outflow, right? So even though the truck goes to the balance sheet, we need to note the entire purchase price (if we paid cash) on our cash flow statement.

Now we sold a truck for cash! We will remove the truck from the balance sheet, and stop the depreciation, but whatever we received in cash for the truck will show up on our investing section on our cash flow statement. This will be an inflow.

We might also buy stock (cash outflow) or sell stock (cash inflow). Maybe we lend money to another company (cash outflow) or collect money on a loan we previously gave (cash inflow).

So if you invest in property, plant, equipment, stocks, bonds or another company, these are all investment activities on your cash flow statement. Here is a little chart to help make this a little easier:

Financing Activities

So the third part of the cash flow statement involves financing activities. If a company borrows money, this is a financing activity. There are some inflows from financing activities including borrowing money or selling common stock. Outflows from financing activities include paying the principal part of debt (a loan payment), buying back your own stock or paying a dividend to investors.

Ready to jump in? Let's start with this video explanation:

If a company borrows money, the entire amount of the cash comes in at one time, right? So that entire amount will be reflected on your cash flow statement.

Let's look at inflows and outflows from financing activities:

Can you think of any other activities that may be considered financing activities? If you look at your personal expenditures, a car loan or mortgage might be a financing activity!

Direct Method versus Indirect Method

There are two ways we can build a cash flow statement. Both ways end up at the same answer, but in a different way.

The direct method, the income statement is reformulated on a cash basis, rather than an accrual basis from the top of the statement (the income part) to the bottom (the expense part).

The indirect method works from net income, so the bottom of the income statement, and adjusts it to the cash basis. We will look at both methods with the same data, so you can see the differences in analysis, but the same ending number.

The Indirect Method

Let's look at the indirect method first. The indirect method starts with your net income and adds or subtracts the items based on changes in their balances.

Remember the operating activities that affect cash flow:

There are related accounts on the balance sheet, so that when changes happen, we need to know how they affect the statement of cash flows:

This can be a confusing concept, so let's look at some examples.

1/1/20XX Accounts Receivable Balance $5000

1/31/20XX Accounts Receivable Balance $4000

The account balance decreased, so we need to add $1000 to our cash for the month because we received that much more in cash from our customers.

Let's look at another example:

1/1/20XX Accounts Payable Balance $8000

1/31/20XX Accounts Payable Balance $5000

The account balance decreased so we need to subtract $3000 from our cash for the month because we paid down our accounts payable balance.

If you are working on a cash flow statement, you can keep the little chart with you. Complete the practice question to check your understanding.

The Direct Method

Sales are great at your company, but cash flow is a mess! You are working on your cash flow statement trying to figure out what is going on. When you look at your income statement, you see sales of $20,000, which is an increase of 50 percent over last month! This is amazing. Why then, are you needing to take money out of your working capital line of credit to cover payroll? These are the questions a good cash flow statement can answer.

When working from the income statement and taking it back to cash basis from the accrual basis, some of the answers to these questions become very clear. Once you take a look you notice that payroll expense was higher to meet the higher sales demand. But since you offer net30 day terms to your customers, you are waiting on payment from them. The hope is this is a short term blip while your cash received from customers comes in to cover your line of credit payment. So what looks good on an income statement, could create temporary or long term cash flow issues!

Let's dig in a little further and discuss the direct method of preparing your cash flow statement. Step back over and watch this video for an overview of the difference between the direct method and indirect method of preparing the operating section of the statement of cash flows:

So the direct method, starts with the income statement and rebuilds it on the cash basis. Most companies operate on the accrual basis, where income is recognized when it is earned and expenses are recognized when they occur, so in order to see how much cash we spent or earned, we need to adjust those amounts to the actual cash we spent or received.

- Burrows Module 8: Business Plan Assignment Article Information Research articles: Google any article on Small Buisness, You must find an article that relates to the subject matter(s) discussed within Module 8 or find an article of interest. (5 points) a. Title of Article, Author, Date of Article (if given) b. Source (Which website used) Q a. Title of Article, Author, Date of Article (if given) B IVE Type to add text.. b. Source (Which website used) BIUE Type to add text.. Body: Brief Summary of the Article Consider the following questions. (6 points) . Who?, What?, When? Where?, Why?, How? It may not be possible to answer every one of these questions - use them as a general guideline when writing your summary. Submit Summary Here Click to choose file. Opinion/Reflection Reflect on what you learned from reading this article. Consider the following: (10 points) a. How can/does this information apply to real life? b. How might you or someone else use this information now or in the future? c. What did you find most interesting and why? d. What questions might you have after reading this article and how might you be able to find out the answers? e. Did you agree or disagree with the content? Why or why not? a. How can/does this information apply to real life? BIU Type to add text.. b. How might you or someone else use this information now or in the future? BIUE Type to add text.. c. What did you find most interesting and why? BIU Type to add text. d. What questions might you have after reading this article and how might you be able to find out the answers? BIU Type to add text. e. Did you agree or disagree with the content? Why or why not? B I U E Type to add text