A statement of cash flows is a required statement and an integral component of financial statements prepared in accordance with generally accepted accounting principles (GAAP). The cash flow statement reports the company’s cash receipts and disbursements made during a period of time, by classifying them into three areas: 1) cash flows from operating activities, 2) cash flows from investing activities, or 3) cash flows from financing activities. In addition, certain noncash transactions that affect a company’s financial position must also be disclosed as part of the cash flow statement.
Cash Flows from Operating Activities
Cash flows from operating activities shows the amount of cash the company has received or paid during the period, directly related to the operations of the company. Cash flows from operating activities can be reported using either the indirect method or by using both the indirect and direct methods.
The indirect method is required for financial statements prepared in accordance with GAAP and begins with the company’s net income and makes adjustments for 1) noncash items such as depreciation, amortization, gains and losses associated with the disposal of noncurrent assets, unrealized gains and losses on marketable securities and deferred income taxes; and 2) changes during the period in current operating assets and liabilities. The reconciliation will show separately all major classes of operating items, including changes in receivables and payables related to operating activities, as well as changes in inventory. An exception to this is that some operating assets and liabilities may include items related to financing or investing activities and they are excluded from cash flows from operating activities and are included in the other respective areas of the cash flow statement. For example, the change in accounts payable may include items related to investing or financing activities, such as equipment purchased on account or dividends payable.
When a company chooses to also report cash flows from operating activities using the direct method, the cash flow statement begins with gross cash receipts from operating sources and deducts gross cash disbursements for operating costs and expenses. The statement will list, at a minimum, the following categories of cash receipts and cash disbursements from operating activities: 1) cash collected from customers, including lessees and licensees, 2) interest and dividends received, 3) other operating cash receipts, if any; 4) cash paid to employees and other suppliers of goods or services, 5) interest paid,
6) income taxes paid, and 7) other operating cash disbursements, if any. When both methods are used, each method will result in the same amount of cash flows from operating activities.
Cash flows from operating activities is the most accurate assessment of how much cash a company has generated or used during the period from its core business.
Cash Flows from Investing Activities
Cash flows from investing activities reports the amount of cash the company received or paid during the period related to selling or buying long-term capital assets. These assets include equipment, property, machinery, vehicles, furnishings or investment securities. Over time, a healthy business will demonstrate that the business can pay for these investments with income from its operations.
Cash Flows from Financing Activities
Cash flows from financing activities shows the amount of cash the company received from or paid to lenders, investors and other creditors. This will include receipts and disbursements of cash relating to short or long-term borrowings and equity instruments of the company, as well as dividends and other distributions to owners of the company.
Noncash Investing and Financing Transactions
Certain noncash investing and financing transactions are required to be disclosed as part of the cash flow statement and are excluded from the three areas described above. These transactions include acquiring non-operating assets, such as property and equipment by assuming liabilities and issuing stock in exchange for a subscription receivable or other noncash consideration. Also, if the direct method is not used a company is required to disclose the amount of cash paid for interest and income taxes.
A good understanding of this statement and the cash flow activity in your business is a valuable tool to understanding and managing your business.