Investing Activities: Videos & Practice Problems

The statement of cash flows provides crucial insights into a company's financial health, particularly through the cash flows from investing activities, which are directly related to long-term assets on the balance sheet. These activities encompass the purchase and sale of long-term assets, such as equipment, land, and investments. Cash inflows occur when a company sells its plant assets, including land, equipment, intangibles, or long-term investments, while cash outflows arise from purchasing these same types of assets.

Understanding the journal entries associated with these transactions is essential for accurately reporting investing cash flows. For instance, when a company sells equipment, the cash received from the sale represents the investing cash flow. If equipment was purchased for $20,000 with accumulated depreciation of $14,000 and sold for $8,000, the cash flow from this transaction would be $8,000. This amount is recorded as an inflow in the cash flow statement under investing activities.

In cases where the selling price is not provided, one might be given the gain or loss on the sale, along with the historical cost and accumulated depreciation. The journal entry for the sale must balance, which involves debiting accumulated depreciation and crediting the equipment account at its historical cost. If the total debits exceed the credits, the difference is recorded as a gain; conversely, if credits exceed debits, it results in a loss. For example, if the equipment is sold for $4,000 instead of $8,000, the cash inflow remains $4,000, but the transaction would reflect a loss on the sale.

Additionally, the flow of transactions through the equipment account illustrates how purchases increase the account, while sales decrease it. Purchases of equipment are classified as investing outflows, while the sale of equipment removes its historical cost from the books but does not directly indicate the cash flow. The accumulated depreciation account, being a contra asset, has a credit balance and is affected by depreciation expense and the sale of assets. Understanding these dynamics is crucial for analyzing cash flows and accurately reporting them in financial statements.

Understanding cash flows from investing activities is crucial for analyzing a company's financial health. Investing activities primarily involve the purchase and sale of long-term assets, such as land and equipment. To calculate cash flows from investing activities, one must examine changes in long-term asset accounts on the balance sheet and consider any additional information provided.

For instance, if a company’s land account increased from $20,000 to $130,000, this indicates a purchase of land worth $110,000. Similarly, if equipment increased from $50,000 to $187,000, it suggests that new equipment was acquired, likely involving a cash outflow. Accumulated depreciation, a contra asset account, also changes due to depreciation expense, which in this case increased from $6,000 to $14,000, reflecting an additional $8,000 in depreciation.

When analyzing an income statement, one might notice a depreciation expense of $9,000. However, if accumulated depreciation only increased by $8,000, it implies that there was another factor affecting this account, such as the sale of equipment, which could also result in a loss on disposal.

To calculate net cash provided or used by investing activities, one must consider all relevant transactions. For example, if a company sold equipment with a book value of $7,000 for $4,000 in cash, this cash inflow is recorded as a positive cash flow from investing activities. Conversely, if the company purchased land for $110,000 and new equipment for $145,000, these transactions represent cash outflows.

In summary, the cash flow from investing activities can be calculated as follows:

Net Cash Flow from Investing Activities = Cash Inflows - Cash Outflows

Using the example provided, the calculation would be:

Net Cash Flow = $4,000 (from equipment sale) - $110,000 (land purchase) - $145,000 (equipment purchase) = -$251,000

This results in a net cash outflow of $251,000 from investing activities. While a negative cash flow may seem unfavorable, it can indicate that the company is investing in its growth, which may lead to stronger future cash flows. Investors can leverage this information to assess the company's long-term viability and growth potential.

To further solidify understanding, practicing similar problems related to investing activities can enhance proficiency in analyzing cash flows and making informed financial decisions.