When developing a pro forma income statement, which of the following is most directly used to estimate cash flows from operating activities on the statement of cash flows?

• A. Total assets at the end of the period
• B. Dividends declared during the period
• C. Retained earnings from the previous year
• D. Net income adjusted for non-cash items and changes in working capital

Answer: (D)

Verified step by step guidance

1. Understand that a pro forma income statement is a financial projection used to estimate future income and expenses, and it is closely tied to the statement of cash flows.
2. Recognize that cash flows from operating activities are primarily derived from net income, which is adjusted for non-cash items (e.g., depreciation, amortization) and changes in working capital (e.g., accounts receivable, inventory, accounts payable).
3. Identify that non-cash items are added back to net income because they do not involve actual cash outflows, while changes in working capital reflect the cash impact of operational activities.
4. Exclude other options such as total assets, dividends declared, and retained earnings from the previous year, as they are not directly related to estimating cash flows from operating activities.
5. Conclude that the correct approach to estimate cash flows from operating activities is to start with net income and adjust it for non-cash items and changes in working capital.