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HUM 2003
FUNDAMENTALS OF COST AND

MANAGEMENT ACCOUNTING
DIGITAL ASSIGNMENT-01
FACULTY:
U.M.GOPALA KRISHNA
NAME:K.VISWESWARA REDDY
REG.NO:21MIC7138
SLOT:E2+TEE2
Explain the process of preparing a cash flow statement using both the
direct and indirect methods.Describe the advantages of each approach
for financial analysis. Why is the cash flow statement essential for
stakeholders, and how does it differ from other financial statements like
the income statement and balance sheet?
Direct Method:
Cash Receipts from Customers:

Calculate total cash received from customers, which typically comes
from sales revenue. It can be derived from sales records or accounts
receivable collections.
Cash Payments to Suppliers:

Sum up payments made for inventory and services. This can include
payments to suppliers for raw materials, goods purchased for resale, or
operational services.
Cash Payments to Employees:

Aggregate the payroll expenses, including salaries, wages, and other
employee benefits.
Cash Payments for Other Operating Expenses:

Include expenses such as rent, utilities, insurance, and other overhead
costs.
Cash Payments for Interest and Taxes:

Account for interest payments on loans and income tax payments.
Advantages of the Direct Method:

Clarity and Simplicity: Provides a straightforward view of actual cash
flows, making it easier for stakeholders to understand.
Detailed Information: Allows for a granular look at cash inflows and

outflows, which can be useful for operational decision-making.
Granular Detail: The direct method provides specific cash flows related
to operations, which can help analysts understand exactly where cash is
generated and spent.
Operational Insight: Investors and managers can see cash-based
profitability and efficiency in receiving payments or managing cash
expenses.
Useful for Budgeting: Since the direct method shows exact cash in and
out for specific activities, it aids in more precise budget planning and
forecasting.
Indirect Method:
Start with Net Income:

Begin with the net income figure from the income statement.
Adjust for Non-Cash Items:

Add back non-cash expenses such as depreciation and amortization.
These expenses reduce net income but do not affect cash flow.
Adjust for Changes in Working Capital:

Account for changes in current assets and liabilities, such as:
Accounts Receivable:
Increases in accounts receivable reduce cash, while decreases increase
cash.
Inventory:
Increases in inventory reduce cash, while decreases increase cash.
Accounts Payable:
Increases in accounts payable increase cash, while decreases reduce
cash.
Adjust for Gains and Losses:

Add back losses and subtract gains that are related to investing and
financing activities, as these are not part of operating cash flow.
Advantages of the Indirect Method:

Link to Financial Statements: Provides a clear reconciliation of net
income to net cash from operating activities.
Ease of Preparation: Utilizes information readily available from the

income statement and balance sheet, making it less complex to prepare
than the direct method.
Links to Net Income: By starting with net income, it shows how cash
differs from profits, revealing the impact of non-cash transactions and
accruals.
Simplicity and Standardization: The indirect method is easier to prepare

and understand because it uses figures readily available from the income
statement and balance sheet.
Performance Insights: By reconciling net income with cash flow, it helps

stakeholders assess earnings quality. It reveals if profits are truly
supported by cash or inflated by non-cash entries (like receivables that
haven’t been collected).
Importance of the Cash Flow Statement:

The cash flow statement is essential for stakeholders because it provides
a clear picture of a company's liquidity and financial health. It shows
how well the company generates cash to pay its debt obligations, fund
its operating expenses, and support its investments.
Liquidity and Solvency: Provides insights into a company’s ability to

generate cash and meet its short-term obligations.
Investment Decisions: Helps investors understand the company’s cash

generation capabilities, which is crucial for assessing its financial health
and potential for growth.
Evaluating Cash Reserves: The statement reveals if cash inflows from

operations are enough to cover capital expenditures, debt payments,
and dividends, providing insight into financial health.
Risk Assessment: Stakeholders, especially lenders, use the cash flow

statement to gauge the risk of lending. Strong operating cash flow
indicates the business can meet debt obligations without relying on
external funding.
Operational Efficiency: Highlights how effectively a company manages

its cash from operations, which can inform decisions about operational
improvements or cost-cutting measures.
Differences Between Cash Flow Statement and Other Financial

Statements
Cash Flow Statement vs. Income Statement
Cash vs. Accrual Basis: The income statement follows the accrual basis,
recording revenue and expenses when they are incurred, not necessarily
when cash is received or paid. The cash flow statement, however,
records only actual cash transactions.
Profitability vs. Liquidity: The income statement measures profitability

(revenues minus expenses) while the cash flow statement shows
liquidity (actual cash available).
Non-Cash Items: The income statement includes non-cash items like
depreciation, which are added back in the cash flow statement to give a
true cash position.
Cash Flow Statement vs. Balance Sheet
Static vs. Dynamic: The balance sheet is a snapshot of the company’s

financial position at a single point, showing assets, liabilities, and equity.
The cash flow statement shows a dynamic view of cash inflows and
outflows over a period.
Working Capital Changes: The cash flow statement reflects changes in

working capital over time, while the balance sheet only shows the
ending balances.
Operating Activities:
Reflects cash flow from primary business operations.Includes cash
receipts from sales, cash payments for goods and services, and cash
payments to employees.
Investing Activities:
Reflects cash flow from buying and selling assets.Includes purchases of
equipment, investments in securities, and sales of assets.
Financing Activities:
Reflects cash flow from debt and equity financing.Includes issuing stocks
or bonds, repaying loans, and paying dividends.
Why Stakeholders Care:
Investors: Evaluate the company’s ability to generate cash and sustain

operations.
Creditors: Assess the company’s ability to repay loans and manage debt.
Management: Make informed decisions about investments, operations,

and financing.

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HUM 2003

FUNDAMENTALS OF COST AND

Cash Receipts from Customers:

Cash Payments to Suppliers:

Cash Payments to Employees:

Cash Payments for Other Operating Expenses:

Cash Payments for Interest and Taxes:

Advantages of the Direct Method:

Detailed Information: Allows for a granular look at cash inflows and

Start with Net Income:

Adjust for Non-Cash Items:

Adjust for Changes in Working Capital:

Adjust for Gains and Losses:

Advantages of the Indirect Method:

Ease of Preparation: Utilizes information readily available from the

Simplicity and Standardization: The indirect method is easier to prepare

Performance Insights: By reconciling net income with cash flow, it helps

Importance of the Cash Flow Statement:

Liquidity and Solvency: Provides insights into a company’s ability to

Investment Decisions: Helps investors understand the company’s cash

Evaluating Cash Reserves: The statement reveals if cash inflows from

Risk Assessment: Stakeholders, especially lenders, use the cash flow

Operational Efficiency: Highlights how effectively a company manages

Differences Between Cash Flow Statement and Other Financial

Cash Flow Statement vs. Income Statement

Profitability vs. Liquidity: The income statement measures profitability

Static vs. Dynamic: The balance sheet is a snapshot of the company’s

Working Capital Changes: The cash flow statement reflects changes in

Why Stakeholders Care:

Investors: Evaluate the company’s ability to generate cash and sustain

Management: Make informed decisions about investments, operations,

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