Operating Activities in Cash Flows

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1. Comment on the difference between net cash provided by operating activities and net income. Speculate on which number is likely to be the better indicator of long-term profitability. The statement of cash flows is divided into operating, financing and investing activities, and then within each section, the sources and uses of the are provided in greater detail. Net cash provided by operating activities indicates the net sources and uses of cash in operating activities. The statement of cash flows helps determine the inflows and outflows of cash which, in turn, helps an entity determine how effectively it is converting its revenues to free cash flow. Free cash flow is one of the best metrics to determine the profitability of a company. Free cash flow is determined by analysing the operating, investing and financing section of the statement of cash flows. Generally, free cash flow is cash flows provided by operating activities less cash flows used by investing activities for the purchases of plant, property and equipment and the repayment of long-term debt. If there is cash left over, it is “free” to be distributed to the owners of the entity or reinvested in the business. Over time, the entity that generates the highest free cash flow will be the most successfully financial company in terms of return on the owners’ investments. There are generally a number of differences between cash provided by operating activities and net income. The most obvious differences are that net income is presented on an accrual basis and that net income includes non-cash expense and income items. For instance, if an entity makes and delivers a large sale this will be reflected in net income even if the cash hasn’t been collected yet. Further, net income will include non-cash items such as depreciation expense, amortization expense, and certain allowances and charges. Net
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