Purpose
Statement of Cash Flow - Simple Example
for the period 1 Jan 2006 to 31 Dec 2006
Cash flow from operations $4,000
Cash flow from investing ($1,000)
Cash flow from financing ($2,000)
Net cash flow $1,000
Parentheses indicate negative values
The cash flow statement was previously known as the flow of funds statement.[2] The cash flow statement reflects a firm's liquidity.
The statement of financial position is a snapshot of a firm's financial resources and obligations at a single point in time, and the income statement summarizes a firm's financial transactions over an interval of time. These two financial statements reflect the accrual basis accounting used by firms to match revenues with the expenses associated with generating those revenues. The cash flow statement includes only inflows and outflows of cash and cash equivalents; it excludes transactions that do not directly affect cash receipts and payments. These non-cash transactions include depreciation or write-offs on bad debts or credit losses to name a few.[3] The cash flow statement is a cash basis report on three types of financial activities: operating activities, investing activities, and financing activities. Non-cash activities are usually reported in footnotes.
The cash flow statement is intended to[4]
provide information on a firm's liquidity and solvency and its ability to change cash flows in future circumstances
provide additional information for evaluating changes in assets, liabilities and equity
improve the comparability of different firms' operating performance by eliminating the effects of different accounting methods
indicate the amount, timing and probability of future cash flows
The cash flow statement has been adopted as a standard financial statement because it eliminates allocations, which might be derived from different accounting methods, such as various timeframes for depreciating fixed assets.[5]
History and variations
Cash basis financial statements were very common before accrual basis financial statements. The "flow of funds" statements of the past were cash flow statements.
In 1863, the Dowlais Iron Company had recovered from a business slump, but had no cash to invest for a new blast furnace, despite having made a profit. To explain why there were no funds to invest, the manager made a new financial statement that was called a comparison balance sheet, which showed that the company was holding too much inventory. This new financial statement was the genesis of cash flow statement that is used today.[6]
In the United States in 1973, the Financial Accounting Standards Board (FASB) defined rules that made it mandatory under Generally Accepted Accounting Principles (US GAAP) to report sources and uses of funds, but the definition of "funds" was not clear. Net working capital might be cash or might be the difference between current assets and current liabilities. From the late 1970 to the mid-1980s, the FASB discussed the usefulness of predicting future cash flows.[7] In 1987, FASB Statement No. 95 (FAS 95) mandated that firms provide cash flow statements.[8] In 1992, the International Accounting Standards Board issued International Accounting Standard 7 (IAS 7), Cash Flow Statement, which became effective in 1994, mandating that firms provide cash flow statements.[9]
US GAAP and IAS 7 rules for cash flow statements are similar, but some of the differences are:
IAS 7 requires that the cash flow statement include changes in both cash and cash equivalents. US GAAP permits using cash alone or cash and cash equivalents.[5]
IAS 7 permits bank borrowings (overdraft) in certain countries to be included in cash equivalents rather than being considered a part of financing activities.[10]
IAS 7 allows interest paid to be included in operating activities or financing activities. US GAAP requires that interest paid be included in operating activities.[11]
US GAAP (FAS 95) requires that when the direct method is used to present the operating activities of the cash flow statement, a supplemental schedule must also present a cash flow statement using the indirect method. The IASC strongly recommends the direct method but allows either method. The IASC considers the indirect method less clear to users of financial statements. Cash flow statements are most commonly prepared using the indirect method, which is not especially useful in projecting future cash flows.
Cash flow activities
The cash flow statement is partitioned into three segments, namely:
cash flow resulting from operating activities;
cash flow resulting from investing activities;
cash flow resulting from financing activities.
The money coming into the business is called cash inflow, and money going out from the business is called cash outflow.
Operating activities
Operating activities include the production, sales and delivery of the company's product as well as collecting payment from its customers. This could include purchasing raw materials, building inventory, advertising, and shipping the product.
Under IAS 7, operating cash flows include:[11]
Receipts for the sale of loans, debt or equity instruments in a trading portfolio
Interest received on loans
Payments to suppliers for goods and services
Payments to employees or on behalf of employees
Interest payments (alternatively, this can be reported under financing activities in IAS 7)
buying Merchandise
Items which are added back to [or subtracted from, as appropriate] the net income figure (which is found on the Income Statement) to arrive at cash flows from operations generally include:
Depreciation (loss of tangible asset value over time)
Deferred tax
Amortization (loss of intangible asset value over time)
Any gains or losses associated with the sale of a non-current asset, because associated cash flows do not belong in the operating section (unrealized gains/losses are also added back from the income statement).
Dividends received
Investing activities
Examples of Investing activities are
Purchase or Sale of an asset (assets can be land, building, equipment, marketable securities, etc.)
Loans made to suppliers or received from customers
Payments related to mergers and acquisition.
Financing activities
Financing activities include the inflow of cash from investors such as banks and shareholders, as well as the outflow of cash to shareholders as dividends as the company generates income. Other activities which impact the long-term liabilities and equity of the company are also listed in the financing activities section of the cash flow statement.
Under IAS 7,
Payments of dividends
Payments for repurchase of company shares
For non-profit organizations, receipts of donor-restricted cash that is limited to long-term purposes
Items under the financing activities section include:
Dividends paid
Sale or repurchase of the company's stock
Net borrowings
Repayment of debt principal, including capital leases
