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I've been following this Udemy course on finance and valuation basics (Link). I am particularly confused when it comes to the cash flow statement part, specifically on how to get Operating Cash Flow (Net Cash from Operating Activities) using line items on the Balance Sheet and Income Statement. Below is a snapshot of an example calculation from the course.

Operating Cash Flow Calculation

I understand that Net Income should be adjusted for noncash items to get operating cashflow. For example, I get why depreciation is added back to Net Income, because in the Income Statement it is explicitly stated and deducted from the revenue. But I do not understand why Accounts Payable, Accounts Receivable, and Increase in Inventory are included in this adjustment. I know they are noncash items, but they aren't explicitly stated in the Income Statement when you are calculating Net Income initially.

My guess is that these items are already included beforehand in the Revenue (which is not shown explicitly anywhere in the financial report), which is why we still need to subtract/add them back when calculating operating cash flow. Is this correct or did I miss something? Thanks.

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Your understanding of the mechanics of the construction of a cash flow statement is correct.

The cash flow statement, which operating cash flow is part of, is a reconciliation of net profit from the income statement and cash from the balance sheet. Therefore, adjustments in the cash flow statement include items both from the income statement and the balance sheet.

Changes in accounts receivables, payables, and inventories are accounted for in the cash flow statement not because they are non-cash cost items like current depreciation. An increase in accounts receivable, for example, is deducted from net profit in the cash flow statement because any increase in accounts receivable means the company has not been able to collect that much of money from its customers even if the sale has been made.

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    $\begingroup$ A sale on credit increases revenue and increases accounts receivable, with no impact on cash. Only when the customer pays his bill does the accountant increase cash and decrease accounts receivable. Hence to compute what we might call "revenue in cash" during a period we must subtract from "revenue" the increase in A/R during the period. A/P works the opposite way, the accountant has recorded a cost but this cost has not used up any cash yet, until the A/P is paid. $\endgroup$
    – nbbo2
    Sep 27, 2021 at 13:43
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    $\begingroup$ Thx for the comment. Pls note that one can not reliably compute "revenue in cash" during a period most of the time by subtracting the increase in A/R during the period because the increase in A/R is net of payments, if any, towards A/R accumulated in previous periods. The increase in A/R solely attributed to the sales in the reported period is rarely disclosed. $\endgroup$
    – Alper
    Sep 27, 2021 at 18:08
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The way accounting is done for these might help:

When you sell something: DR Accts Receivable, CR Revenue

So you have added to Revenue and therefore net income, but you did not get any cash. You got an increase in Accts Receivable.

Similarly, when you buy something: DR Expense, CR Accts Payable

Your income would go down because expenses increased, but you did not pay for it with cash, but with an increase accts payable.

So that's why even though from an income statement, you have an increase in Revenue or an increase in Expense, neither affected actual cash. To get the actual change in cash, you need to subtract the increase in Accts Receivable and add back the increase in Accts Payable.

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