2.
Components of the Table
The table in the image is structured as follows:
A. Income Statement Items (Accrual-Based)
These are the revenues and expenses recorded in the income statement using the accrual method
of accounting.
B. Adjustments (Converting to Cash Basis)
Since the income statement records revenues when earned (not necessarily when cash is
received) and expenses when incurred (not necessarily when paid), adjustments are needed to
reflect actual cash movements.
Here’s how each item is adjusted:
1. Sales (Revenue)
o Increase in Accounts Receivable (-) → If sales were made on credit, cash hasn’t
been received yet.
o Decrease in Accounts Receivable (+) → If past credit sales have been collected,
it's a cash inflow.
o Increase in Deferred Revenue (+) → If customers paid in advance, it's a cash
inflow.
o Decrease in Deferred Revenue (-) → If previously deferred revenue is now
recognized, it’s not new cash.
✅ Final Cash Flow Component: Collections from Customers
2. Interest and Dividend Revenue
o Decrease in Interest Receivable (+) → If past interest income was collected in
cash.
o Increase in Interest Receivable (-) → If interest was earned but not yet received.
o Amortization of Bond Premium (-) / Discount (+) → Adjustments related to
investment earnings.
✅ Final Cash Flow Component: Interest and Dividends Collected
3. Other Revenue (Unearned Revenue, Gains, Investment Income)
o Unearned Revenue Increases (+) → Customers paid in advance.
o Unearned Revenue Decreases (-) → Recognized revenue from past advances
(not new cash).
o Gains/Losses on Asset Sales → Gains are non-cash, but actual sale proceeds are
cash.
✅ Final Cash Flow Component: Other Operating Receipts
4. Cost of Goods Sold (COGS)
o Increase in Inventory (-) → More inventory purchased means cash outflow.
o Decrease in Inventory (+) → Less inventory means lower cash outflow.
o Increase in Accounts Payable (+) → Bought on credit, not yet paid.
o Decrease in Accounts Payable (-) → Paid suppliers, cash outflow.
✅ Final Cash Flow Component: Payments to Suppliers
5. Operating Expenses (Selling, Admin, and Depreciation)
o Depreciation, Amortization (+) → These are non-cash expenses, ignored in the
Direct Method.
o Increase in Accrued Expenses (+) → Expenses incurred but not yet paid (no
cash outflow).
o Decrease in Accrued Expenses (-) → Paid off past expenses (cash outflow).
o Increase in Prepaid Expenses (-) → Paid in advance (cash outflow).
o Decrease in Prepaid Expenses (+) → Used up prepaid expenses (no new cash
outflow).
✅ Final Cash Flow Component: Payments for Operating Expenses
6. Interest Expense
o Decrease in Interest Payable (-) → Paying off interest liabilities (cash outflow).
o Increase in Interest Payable (+) → Interest incurred but not yet paid (no cash
outflow).
o Bond Discount Amortization → Adjustments to bond interest expenses.
✅ Final Cash Flow Component: Payments of Interest
7. Income Tax Expense
o Decrease in Income Taxes Payable (-) → Paying off tax liabilities (cash
outflow).
o Increase in Income Taxes Payable (+) → Taxes incurred but not yet paid (no
cash outflow).
o Deferred Tax Adjustments → Adjustments for timing differences in tax
payments.
✅ Final Cash Flow Component: Payments of Income Taxes
Free Cash Flow (FCF) is the amount of cash a company has left after covering its capital
expenditures (investments in fixed assets) and dividends. It represents the cash available for:
Additional investments
Paying off debt
Distributing to shareholders
Strengthening liquidity
Formula for Free Cash Flow
Net Cash Provided by Operating Activities (Operating Cash Flow): This is the cash generated from the
company's normal business operations.
Capital Expenditures (CAPEX): Money spent on acquiring or upgrading physical assets like
buildings, equipment, or technology.
Dividends: Cash payments made to shareholders.