1.2.3.1. Operating Activities
The first section of a cash flow statement covers operating activities, i.e., the day-to-day functioning of the business. Typically, this section starts with the net income shown on the income statement and adjusts this figure so that it represents only the cash the company actually received or spent during the period due to operating activities.
From the net income, subtract income that has been recognized as accrued, but has not been paid to the company. Then, add back in expenses that have been recognized as accrued, but have not been paid by the company. This explains why, when you look under operating activities in the example cash flow statements below, you will see that noncash items such as depreciation are listed as credits. Because depreciation is an accounting concept, not an actual cash expenditure, the subtraction of depreciation must be reversed when converting net income to net cash.
Think of noncash items as being “invisible” to the cash flow statement. Every noncash item subtracted along the way—from net revenues to gross profit to operating income to net income—it all gets added back in. Likewise, noncash items added along the way, like an increase in accounts receivable during the period, get taken back out.
On the exam, changes to any current assets or liabilities may be referred to by the blanket term “changes to working capital.” (We’ll talk more about working capital in Chapter 3, but basically it is a term for the difference between current assets and current liabilities.) Only the changes to working capital are relevant here. For example, if accounts receivable increased by $300, you would deduct $300 from net income. It makes no difference whether the increase was from $1,000 to $1,300, or from $1,000,000 to $1,000,300.
Example Question
Thompson Office Supplies begins a new fiscal year on January 1, 2023. On this date, it has $10,000 in accounts receivable from business it did in