![]() When the company disposes of an asset, the difference between the proceeds received and the net book value of the asset sold is recognized as a component of net income. If the proceeds exceed the net book value, the sale will result in a gain, and if the proceeds are less than net book value, the company will record a loss. While the resulting gain or loss influences reported net income, it does not represent a source of operating cash flow. As a result, gains are deducted from (and losses are added to) reported net income in the reconciliation of operating cash flow. Non-cash charges. Some expenses do not correspond to cash outflows in the current year. Depreciation is an allocation of amounts spent in prior years on long-lived assets. Amortization assigns the cost of acquired identifiable intangible assets to the years following the acquisition. Equity-based compensation expense recognizes promised payments to employees in future periods for services rendered in the current period. Since the purpose of the operating activities section is to reconcile reported net income to cash flow, these non-cash charges are added to reported net income.Net income is not synonymous with operating cash flow. The purpose of the operating activities section of the statement of cash flows is to reconcile the two figures. While the operating activities section often includes a dizzying number of reconciling entries, they generally fall into three categories: The statement of cash flows is divided into three sections, with all sources of cash flow and uses of cash classified as operating, investing, or financing activities. Key Components of the Statement of Cash Flows The statement of cash flows reconciles the change in cash balance during the period by reference to reported earnings, non-cash charges, changes in balance sheet accounts, capital expenditures and other investments, and transactions with lenders and shareholders. While often overlooked, the experienced financial statement reader knows that the statement of cash flows reveals the company’s fundamental underlying narrative more clearly than either the balance sheet or income statement do in isolation. ![]() ![]() The balance sheet, income statement, and statement of cash flows are each indispensable components of the “story” that the financial statements tell about a company.Īn accounting professor of mine referred to the statement of cash flows as the “desert island” financial statement because if he were stranded on a desert island and could have only one financial statement with which to analyze a company, he would want it to be the statement of cash flows. While sincerely hoping never to find myself in such a position, I do believe there is merit to the sentiment. This post is the third of four installments from our Basics of Financial Statement Analysis whitepaper. In this series of posts, our goal is to help readers develop an understanding of the basic contours of the three principal financial statements.
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