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Part 2: Your Current Nest Egg

The operating cash flow ratio represents a company’s ability to pay its debts with its existing cash flows. A ratio greater than 1.0 indicates that a company is in a strong position to pay its debts without incurring additional liabilities. Given that it is only a book entry, depreciation does not cause any cash movement and, hence, it should be added back to net profit when calculating cash flow from operating activities. Some fundamental operating activities for a business are sales, customer service, administration and marketing. These activities are part of the normal functioning of a business that affects its monthly, quarterly and annual income and profits.

1. For example, a large sale boosts revenue, but if the company is having difficulty collecting the cash, the sale is not a true benefit for the company.
2. When using the indirect method to calculate operating cash flow, net income is one of the initial variables.
3. Proceeds from sale of equipment 40,000 is a positive amount since this is the amount of cash that was received.
4. If the amounts had added up to a negative amount, the description would be “Net cash used by operating activities”.
5. Regardless of their activities, the ultimate goal of any business is to maximize profits.
6. Free cash flow is calculated as cash flow from operating activities, reduced by capital expenditures, the value for which is normally obtained from the investing section of the statement of cash flows.

Examples of cash outflows for operating activities are cash payments to employees or suppliers, as well as payments of fines or cogs meaning to settle lawsuits. Other examples are cash payments for taxes, refunds paid to customers, and contributions. A business might also make cash payments to settle asset retirement obligations, or to pay interest to creditors.

If the direct method is used, the company must still perform a separate reconciliation to the indirect method. Because of the misplacement of the transaction, the calculation of free cash flow by outside analysts could be affected significantly. Free cash flow is calculated as cash flow from operating activities, reduced by capital expenditures, the value for which is normally obtained from the investing section of the statement of cash flows. As their manager, would you treat the accountants’ error as a harmless misclassification, or as a major blunder on their part? Operating cash flow represents the cash impact of a company’s net income (NI) from its primary business activities.

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This figure represents the difference between a company’s current assets and its current liabilities. Expenses generated from key operating activities include manufacturing costs, as well as the expenses of advertising and marketing the company’s products or services. Manufacturing costs include all the direct production costs included in cost of goods sold (COGS).

Operating Activities and the Cash Flow Statement

Operating activities are the daily activities of a company involved in producing and selling its product, generating revenues, as well as general administrative and maintenance activities. The operating income shown on a company’s financial statements is the operating profit remaining after deducting operating expenses from operating revenues. There is typically an operating activities section of a company’s statement of cash flows that shows inflows and outflows of cash resulting from a company’s key operating activities. Cash flows from financing activities are cash transactions related to the business raising money from debt or stock, or repaying that debt. The cash flow statement provides management, analysts, and investors with insight into a company’s financial well-being.

How Is the Cash Flow Statement Linked to Business Activities?

Net income must be adjusted for changes in working capital accounts on the company’s balance sheet. For example, an increase in AR indicates that revenue was earned and reported in r ise enterprises net income on an accrual basis although cash has not been received. This increase in AR must be subtracted from net income to find the true cash impact of the transactions.

Apart from operating activities, cash flow statement also lists the cash flow from investing and financing activities. Assume you are the chief financial officer of T-Shirt Pros, a small business that makes custom-printed T-shirts. While reviewing the financial statements that were prepared by company accountants, you discover an error.