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year as well as return of capital (if any) to them. Usually, the dealings with debt sources of capital are reported net (i.e., only the net increase or increase is disclosed). Reporting practices are not completely uniform in this regard however. It is acceptable to report borrowings separate from payments on debt instead of just the net increase or decrease. Generally, the issuance of new ownership shares should be reported separately from the return of capital to shareowners.
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    I N T R O D U C I N G F I N A N C I A L S T A T E M E N T S
    The first section of the statement of cash flows, called cash flow from operating activities (which is not the best designation in the world, in my opinion), reports the cash increase or decrease during the year from sales revenue and expense activities. This key figure also is called operating cash flow or cash flow from profit. To be frank, this is not an easy number to understand. In Figure 2.4, I present cash flow from operating activities about as briefly and simply as you can. Cash inflow from sales revenue was $25.7 million during the year, and cash outflow for expenses was $22.4 million during the year, which yields the $3.3 million cash flow from profit operating activities. This manner of presentation is referred to as the direct method.
    Instead of the direct method, a business has the option of using an alternative method for presenting cash flow from operating activities, which is called the indirect method. The large majority of businesses elect the indirect method as a matter of fact—even though the financial reporting rule-making body of the accounting profession has expressed a preference for the direct method. The indirect method is explained next.
    Indirect Method of Reporting Cash Flow
    from Operating Activities
    Based on changes in the operating assets and liabilities from the beginning of the year to the end of the year, Figure 2.5
    shows how the business’s cash flow from operating activities would be presented in its statement of cash flows for the year.
    The indirect method starts with net income for the year, then “adjusts” net income for the cash flow effects due to changes in the assets and liabilities that are directly connected with recording sales revenue and expenses (called operating assets and liabilities). Of course, the $3.3 million cash flow from operating activities for the year is the same whether the direct or the indirect method of presentation is used in the statement of cash flows. To follow the indirect method of presentation, keep in mind the following basic points:
    • An increase in operating assets causes a negative effect on cash flow from profit, and a decrease causes a positive effect.
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    F I N A N C I A L R E P O R T I N G

    Net income
    $2.2

    Accounts receivable increase
    (0.5)

    Inventories increase
    (0.8)
    Prepaid expenses increase
    (0.1)

    Depreciation expense
    1.7

    Advance payments from customers increase
    0.2

    Accounts payable increase
    0.4

    Accrued expenses payable increase
    0.2

    Cash flow from operating activities
    $3.3

    FIGURE 2.5 Indirect method of reporting cash flow from operating activities.

    • An increase in operating liabilities causes a positive effect on cash flow from profit, and a decrease causes a negative effect.

    In most situations, the largest decrease in an operating asset is the depreciation expense recorded for the year. Depre-

    ciation expense is recorded in order to allocate a portion of the total cost of a business’s long-term operating assets to the year. Recording depreciation expense is not a cash outlay; rather, it is the write-down of the long-term operating assets of the business that were bought and paid for in previous TEAMFLY
    years. Note in Figure 2.5 that depreciation expense is by far the largest single factor in cash flow from operating activities.

    s
    END POINT
    A business makes regular financial reports to its shareowners and lenders. Because they supply capital to the