Mastering Cash Flow and Cost Accounting Principles

Cash Flow Statement Fundamentals

Operating Activities (Indirect Method Adjustments)

The calculation starts with the Income Statement components:

• Non-cash expenses (e.g., Depreciation) are typically positive adjustments.
• Losses are generally positive adjustments (added back).
• Gains are generally negative adjustments (subtracted).

Balance Sheet Adjustments (Working Capital Changes)

These adjustments relate to changes in current assets and liabilities:

• Current Assets (e.g., Accounts Receivable, Inventory):
  • Increase in asset balance = Cash Outflow (–)
  • Decrease in asset balance = Cash Inflow (+)
• Current Liabilities (e.g., Accounts Payable):

  Note: Accounts Payable reverses the asset logic.

  • Increase in liability balance = Cash Inflow (+)
  • Decrease in liability balance = Cash Outflow (–)

The result is the Net Cash Flow from Operating Activities.

Investing Activities

These activities relate to the purchase or sale of long-term assets (often derived from the first two items of additional information):

• Assets Sold: Cash Inflow (+) (Gaining cash from the sale).
• Assets Purchased: Cash Outflow (–) (Spending cash to acquire).

The result is the Net Cash Flow from Investing Activities (calculated by summing inflows and subtracting outflows).

Financing Activities

These activities relate to debt, equity, and dividends (often derived from the last items of additional information):

• Debt Issued: Cash Inflow (+) (Acquiring cash).
• Debt Repaid: Cash Outflow (–) (Paying back principal).
• Paid Dividends: Cash Outflow (–).

The result is the Net Cash Flow from Financing Activities.

Summary of Cash Flow

• Net Increase in Cash Flow: Sum of all three Net Cash Flows (Operating + Investing + Financing).
• Beginning Cash Balance: Cash balance at the start of the period.
• Ending Cash Balance: Sum or difference of the previous two items (Net Increase + Beginning Balance).

Key Concepts in Cost Accounting and Finance

Cost Classification and Definitions

• Variable Cost: An example is Direct Cost.
• Main Cost Component in Service-Sector Companies: Labor Cost.
• Period Cost Classification: Typically Marketing costs.
• Inventoriable Cost in Manufacturing: Direct Materials Used in Production.
• Cost Driver: A factor that causes changes in the total cost.
• Budget: An estimate of expenses expected to be incurred during a period.
• Actual Cost: Represents the amount spent.
• Direct Costs: Costs that can be easily traced to the cost object (e.g., materials).
• Indirect Costs: Costs that cannot be easily traced (e.g., indirect labor).
• Importance of Understanding Costs: Essential for adapting to economic possibilities.

Fixed Costs and Relevant Range

• Fixed Costs: Costs that remain unchanged despite changes in activity volume within the relevant range.
• Relevant Range: The range of activity within which cost behavior assumptions (fixed or variable) are valid.

True or False Statements on Cost Behavior

1. The wages of workers directly involved in production are classified as Direct Labor. (True)
2. Fixed costs change proportionally with activity volume. False.
3. The cost of factory utilities that vary with production volume is a variable cost. True.
4. Advances in technology can turn indirect costs into direct costs (by making tracing easier). True.
5. A cost object can only be a product and not a customer or a department. False.

Liquidity and Working Capital

• Working Capital: The difference between current assets and current liabilities.
• Not a Current Asset: Equipment (it is a long-term asset).
• Liquidity: Refers to a company's ability to cover its short-term liabilities.
• Cash Outflow from Financing Activities: Paying dividends.
• Efficient management of the working capital cycle ensures enough cash flow. True.
• A negative cash flow is always bad. False (e.g., heavy investment phase).
• Accounts Payable is an example of a current asset. False (it is a current liability).
• Liquidity is only important for long-term financial health. False (it is crucial for short-term survival).
• Cash flow from investing activities includes cash received from customers. False (that is an operating activity).