BOOKKEEPING TIPS is a twice monthly e-letter published by The American Institute of Professional Bookkeepers (AIPB), Suite 500, 6001 Montrose Road, Rockville, MD 20852. Tel.: 800-622-0121, Fax: 800-541-0066, email: info@aipb.org.

April 20, 2005

Show Your Company What Its Income Statement Never Shows:
Cash Flows from Operations

Make yourself indispensable: Show your company or clients why they have strong profits but no cash—or no profits and lots of cash—for any period by revealing the cash provided by operating activities (CPO), i.e., cash flows from the firm’s primary business activities.

Although the computations for finding the CPO have an intimidating name—reconciling to net income (or net loss)—their major purpose is simple: to convert net income reported on the income statement from the accrual to the cash basis for whatever period you are interested in.

To find CPO, you make two kinds of adjustments to net income:

1. Adjustments for noncash expenses (income statement). When net income is computed, some expenses deducted from revenues do not involve cash. So, when computing CPO, these noncash expense amounts must be added back. For example, depreciation and most amortization decrease net income but neither involve cash outflows, so they must be added back to net income to find CPO.

2. Adjustments for changes in current asset and current liability accounts (balance sheet). To make adjustments for changes in current asset and current liability accounts, you simply determine the change in the account balance for the period. Example: Say that you are computing CPO for the year. If the beginning balance in Accounts Receivable is $1,500 and the year-end balance is $1,800, you will adjust net income by the amount of the change: $300. To compute CPO for a particular quarter, compute the change in the account balance for that quarter.

These adjustments to CPO are made for the following current asset and current liability accounts:

     Accounts receivable   Income tax payable
     Accounts payable      Deferred inc. tax liability
     Inventory                   Deferred inc. tax asset
     Accruals payable       Dividends receivable (but
     Prepaid expenses      not Dividends payable)
     Unearned revenue      Interest receivable
     Interest payable         Discount on notes rec.

Net income                                       25,000
Add:
     Depreciation expense                     40,000
     Increase in income taxes payable    14,000
Subtract:
   Increase in A/R                               (28,000)
   Decrease in accruals payable          (16,000)
CPO                                                  35,000

                   Net income (from the income statement for that period)
Subtract       increases in current asset accounts
    Add         decreases in current asset accounts
Subtract       decreases in current liability accounts
   Add          increases in current liability accounts
   Add          amortization of discount on notes payable
Subtract       amortization of discount on notes receivable
   Add          depreciation expense
Equals:        CPO for the period

Net income                                             $127,000
Depreciation expense                                + 68,000
Increase in accounts receivable                  – 22,000
Amortization of discount on notes rec.         –  2,000
Increase in interest receivable                    – 10,000
Decrease in inventory                               + 15,000
Increase in prepaid rent                          –  4,000
Increase in accounts payable                +  6,000
Decrease in accruals payable                – 11,000
Decrease in interest payable                –  3,000
Amortization of discount on notes pay.      +  1,000
Decrease in unearned service revenue        –  8,000
Increase in income taxes payable            + 16,000
Decrease in deferred income tax liability   –  7,000
Cash provided by operating activities       $166,000

Note that the cash provided by operating activites for the period are significantly higher than the net
income for the same period.



If your company has substantial revenues from investing activities or financing activities, or both,
you can make similar adjustments to reveal company cash flows from these areas.



Be a hero to your company or clients.  Explain to owners, in plain English, how they have high profits and
no cash—or no profits but plenty of cash (and why that may change in the next period). Discover how easy it
can be to master the simple art of computing cash flows step by step with AIPB’s combination self-study
course/desk reference, Mastering the Statement of Cash Flows.
For details, visit www.aipb.org/continuing_education_files/continui_cashflow.html.



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