Last updated on May 6, 2024
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Review the cash receipts and payments
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Reconcile the cash balances
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Trace the cash flows to the income statement and the balance sheet
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Evaluate the reasonableness and completeness of the cash flows
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Test the mathematical accuracy and presentation of the cash flow statement
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Here’s what else to consider
The cash flow statement is one of the most important financial reports for any business. It shows how much cash is generated and used by the operating, investing, and financing activities of the company. The direct method of preparing the cash flow statement is preferred by many users because it provides more detailed information about the sources and uses of cash. However, it also requires more data and analysis than the indirect method, which starts from the net income and adjusts it for non-cash items. How do you audit and verify the cash flow statement using the direct method? Here are some steps you can follow to ensure the accuracy and completeness of the cash flow statement.
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- Kirsha Campbell CPA,CMA 📈Sustainable Cashflow Training 💡Franchise Cashflow, Growth + Profits 💰Cashflow Insights + Growth 💹 Leadership +… 1
1 Review the cash receipts and payments
The first step is to review the cash receipts and payments recorded in the cash book or the general ledger. You need to check that they are classified correctly into operating, investing, and financing activities, and that they are consistent with the bank statements and other supporting documents. You also need to identify any non-cash transactions, such as depreciation, amortization, stock-based compensation, or exchange rate differences, and exclude them from the cash flow statement.
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Understanding and validating the cash flow statement through the direct method involves meticulous analysis of cash receipts and payments from operating activities. By scrutinizing incoming and outgoing cash transactions directly, we ensure transparency and accuracy in depicting the company's cash position. This method not only enhances financial reporting integrity but also provides valuable insights into the organization's liquidity and operational efficiency. I've found that employing this approach fosters a deeper comprehension of cash flow dynamics and facilitates more informed decision-making for stakeholders.
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2 Reconcile the cash balances
The next step is to reconcile the cash balances at the beginning and end of the period. You need to compare the cash balances reported in the cash flow statement with the cash balances shown in the balance sheet and the bank reconciliation statement. You need to explain any differences or discrepancies, such as outstanding checks, deposits in transit, bank errors, or adjustments for reconciling items.
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3 Trace the cash flows to the income statement and the balance sheet
The third step is to trace the cash flows from the operating, investing, and financing activities to the income statement and the balance sheet. You need to verify that the cash flows are derived from the changes in the relevant accounts, such as accounts receivable, inventory, accounts payable, fixed assets, long-term debt, or equity. You also need to check that the cash flows are consistent with the accounting policies, standards, and principles applied by the company.
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4 Evaluate the reasonableness and completeness of the cash flows
The fourth step is to evaluate the reasonableness and completeness of the cash flows reported in the cash flow statement. You need to assess whether the cash flows reflect the nature and performance of the business, and whether they are in line with the industry trends, benchmarks, and expectations. You also need to look for any unusual or significant cash flows, such as large or frequent transactions, related party transactions, or transactions with tax implications, and obtain sufficient audit evidence and explanations for them.
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Testing for reasonableness is definitely important. In addition to the steps mentioned, as a means of testing the reasonableness of the calculated cash flows, we can: ✅Compare the cash flows from each section (from operating activities, financing activities, and investing activities) over multiple periods and question the reason(s) for any significant variances; ✅Compare the cash flows from investing activities to the changes in balances of relevant accounts on the balance sheet (e.g. fixed assets, investments);✅Similarly compare the changes to financing activities with the changes in relevant accounts on the balance sheet (e.g. loan payable, equity accounts).Zoom out and evaluate the numbers in the context of the bigger picture.
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5 Test the mathematical accuracy and presentation of the cash flow statement
The final step is to test the mathematical accuracy and presentation of the cash flow statement. You need to check that the cash flows are added and subtracted correctly, and that the net increase or decrease in cash equals the difference between the cash balances at the beginning and end of the period. You also need to check that the cash flow statement is properly formatted, labeled, and disclosed, and that it complies with the relevant accounting standards and regulations.
By following these steps, you can audit and verify the cash flow statement using the direct method and provide an independent opinion on the reliability and fairness of the financial information.
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6 Here’s what else to consider
This is a space to share examples, stories, or insights that don’t fit into any of the previous sections. What else would you like to add?
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- Kirsha Campbell CPA,CMA 📈Sustainable Cashflow Training 💡Franchise Cashflow, Growth + Profits 💰Cashflow Insights + Growth 💹 Leadership + Planning I Freelance Writer I Speaker🎤
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The cashflow statement should agree with the balance sheet as well as the profit and loss statement or income statement. The cashflow statement shows transactions which affect both balance sheet and profit and loss /income statement.
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