Current Attempt in Progress
Splish Brothers Inc. reported net income of $2 million in 2022. Depreciation for the year was $164,600, accounts receivable decrease $370,900, and accounts payable decreased $252,900. Compute net cash provided by operating activities using the indirect approach. (Show amounts that decrease cash flow with either a – sign e.g. -15,000 or in parenthesis e.g. (15,000).
Splish Brothers Inc. Statement of Cash Flows – Indirect Approach
Adjustments to reconcile net income to
The Correct Answer And Explanation is:
To compute the net cash provided by operating activities using the indirect approach, we start with net income and adjust for non-cash expenses and changes in working capital (current assets and current liabilities).
Splish Brothers Inc.
Statement of Cash Flows – Indirect Method
For the Year Ended December 31, 2022
Cash Flows from Operating Activities:
Net income: ……………………………………………… $2,000,000
Adjustments to reconcile net income to net cash provided by operating activities:
- Depreciation expense: ………………………………. $164,600
- Decrease in accounts receivable: …………………. $370,900
- Decrease in accounts payable: …………………….. $(252,900)
Net cash provided by operating activities: …….. $2,282,600
Explanation (300+ words)
The indirect method for preparing the statement of cash flows starts with the net income, which represents the company’s profitability based on accrual accounting. However, accrual accounting includes non-cash items and timing differences that do not directly affect cash flow. Therefore, adjustments are necessary to reconcile net income to the actual cash generated or used by operating activities.
In this scenario, Splish Brothers Inc. reported a net income of $2 million. This is the starting point.
The first adjustment is depreciation of $164,600. Depreciation is a non-cash expense that reduces net income for accounting purposes but does not involve any cash outflow. Therefore, it must be added back to net income to reflect the true cash flow.
Next, there is a decrease in accounts receivable of $370,900. A decrease in receivables means that the company collected more cash from its customers than it recorded in sales revenue, resulting in an increase in cash flow. Therefore, this amount is added.
On the other hand, accounts payable decreased by $252,900. This indicates that the company paid off some of its outstanding obligations, representing a cash outflow. In the indirect method, a decrease in a current liability such as accounts payable is subtracted from net income.
After making these adjustments, the final amount of net cash provided by operating activities is:
$2,000,000 (net income)
+ $164,600 (depreciation)
+ $370,900 (decrease in A/R)
- $252,900 (decrease in A/P)
= $2,282,600
This figure represents the actual cash generated from core business operations and is vital for understanding a company’s liquidity and ability to fund operations, pay dividends, and invest in growth.