In the financing activities section of the cash flow statement, the focus is on changes in long-term liabilities and equity. Unlike operating activities, which can be analyzed using the indirect or direct method, financing activities stand alone. Key cash inflows in this section include the issuance of bonds or notes payable, which represents borrowing funds, and the issuance of equity, where cash is received in exchange for common stock. Additionally, selling treasury stock contributes to cash inflows.
On the other hand, cash outflows in financing activities typically involve repaying bonds or notes payable, specifically the principal amount, not the interest, which is recorded under operating activities. Paying dividends to shareholders and purchasing treasury stock also represent cash outflows. It is crucial to distinguish that dividends payable, while a current liability, relate to financing activities rather than operating activities.
Understanding the flow of retained earnings is essential. The retained earnings account starts with a beginning balance, which is increased by net income and decreased by dividends declared. It is important to note that the cash flow statement focuses on the payment of dividends, which affects the dividends payable account. When dividends are declared, they increase the dividends payable balance, and paying these dividends reduces that balance, reflecting the cash outflow in financing activities.
To accurately report cash flows, one must be familiar with T-accounts for retained earnings and dividends payable. This knowledge allows for the determination of the actual cash paid in dividends, which is critical for the cash flow statement. Overall, mastering these concepts is vital for understanding the financing activities within the cash flow statement.
