Preparing The Statement Of Cash Flows—Indirect Method

Preparing the statement of cash flows—indirect method with non-cash transactions

Rolling Hills Inc. requires the preparation of a statement of cash flows for the year ended December 31, 2015, using both the indirect and direct methods. The company’s financial data includes an income statement, a comparative balance sheet, and details of non-cash investing and financing activities. This exercise aims to enhance understanding of cash flow statement preparation, emphasizing the indirect method, and to evaluate how this knowledge assists in investment decision-making.

Paper For Above instruction

The statement of cash flows is an essential financial statement that provides insights into a company's cash inflows and outflows over a specific period. It complements the income statement and balance sheet by illustrating how cash is generated and used during operations, investing, and financing activities. Understanding how to prepare and interpret this statement, especially using the indirect method, is vital for investors, managers, and stakeholders to assess a company's liquidity, financial flexibility, and overall financial health.

Rolling Hills Inc. exemplifies a typical manufacturing company with activities spanning operations, investing, and financing during 2015. The challenge lies in accurately translating net income into net cash provided by operating activities, adjusting for non-cash items and changes in working capital, and incorporating non-cash investing and financing transactions such as issuing long-term notes payable for land acquisition.

Preparation of the Statement of Cash Flows – Indirect Method

The indirect method begins with net income and adjusts for non-cash expenses and changes in working capital. For Rolling Hills, net income of $97,800 forms the starting point. Adjustments include adding back depreciation expense of $14,400, subtracting increases in accounts receivable ($1,200), subtracting decreases in merchandise inventory ($11,900), adding increases in accounts payable ($4,900), and subtracting decreases in accrued liabilities ($2,100). These adjustments account for the timing differences and non-cash charges that influence net income but do not affect cash flows during the period.

Next, analyzing investing activities reveals the purchase of equipment and land, with the latter financed through long-term notes payable, which is a non-cash activity that necessitates disclosure in the supplementary section. The sale or disposal of assets, such as land with a book value of $11,560, affects cash flows; however, since it was disposed of at no cash receipt, only the loss or gain impacts the statement indirectly.

Financing activities involve issuing common stock of $23,900, financing a land purchase via long-term notes payable, and paying dividends. These activities impact cash but are not reflected in net income, emphasizing the importance of segregating operating from financing and investing cash flows for a clear understanding of the company's liquidity management.

Calculation and Finalization

By summing all operating, investing, and financing cash flows, the overall net increase/decrease in cash is determined, reconciling the beginning and ending cash balances. In 2015, cash increased from $15,900 to $26,400, signaling a positive cash position, which is vital for assessing ongoing liquidity and capacity to fund future growth.

Application to Investment Evaluation

Learning how to prepare and analyze the cash flow statement directly benefits investment evaluation. Cash flows are less susceptible to accounting manipulations than earnings and provide a clearer picture of operational efficiency and financial stability. Consistent positive cash flows from operating activities indicate a company's ability to sustain operations without external financing, while robust investing and financing activities can highlight strategic growth initiatives or financial weakening.

Informed investors utilize cash flow data to assess a company's liquidity, profitability, and long-term viability. A company with strong operating cash flows, manageable debt, and prudent investment activities signals sound management and competitive advantages, making it a favorable investment. Conversely, persistent negative cash flows or heavy dependence on financing activities may raise red flags about financial sustainability.

Conclusion

Mastering the preparation of the statement of cash flows, especially through the indirect method, is invaluable in financial analysis and investment decision-making. It enables stakeholders to interpret cash generation and usage, discern the quality of earnings, and evaluate strategic positioning. For Rolling Hills Inc., aligning cash flow analysis with financial statements provides a comprehensive understanding of its financial health, aiding investors and managers in making informed decisions about future operations and investments.

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