What is the Statement of Cash Flows?
The statement of cash flows (more commonly called the cash flow statement or CFS) outlines the inflow and outflow of a company’s cash and cash equivalents (CCE).
The CFS gauges how effectively a business manages its cash position and how successfully it generates cash to cover its debt payments and finance its operating costs.
The balance sheet and the income statement are two of the three primary financial statements, and the CFS is the third.
Curious about how it works? Read on to find out.
How is the Statement of Cashflows Used?
The cash flow statement provides information on a company’s operations, sources of funding, and financial transactions. The CFS also aids creditors in determining how much cash is available (known as liquidity) for the business to meet its operational costs and settle its debts.
Investors value the CFS since it informs them of a company’s financial stability and it’s commonly used to make informed decisions about their investments.
What’s on the Statement of Cashflows?
The following are the key elements of the cash flow statement:
- Operating activity cash flow
- Investment cash flow
- Financial activity cash flow
- Non-cash activity disclosure, which is occasionally included when produced in accordance with generally accepted accounting principles (GAAP).
Operating Activity Cash Flow
Any sources and uses of money from commercial operations are included in the operating activities on the CFS. In other words, it shows how much money a company makes from its goods or services.
These operational activities could consist of the following:
- Receipts received from the sale of products and services
- Interest charges
- Payment of income taxes
- Payments made to vendors of the supplies and labor employed in manufacturing
- Employee salaries and wages
- Rent payments
- Any additional operational costs
Where trading portfolios or investment companies are concerned, receipts from the sale of loans, debt, or equity instruments are also included because it is counted as a business activity.
Investment cash flow
Any sources and applications of funds from a company’s investments are considered investing activities.
This category includes any payments made in connection with mergers and acquisitions (M&A), asset purchases or sales, vendor or customer loans, and other payments. In other words, changes to investments, equipment, or assets are considered to be related to cash from investments.
When cash is used to purchase new machinery, structures, or transient assets like marketable securities, changes in cash from investments are typically seen as cash-out items.
Financial activity cash flow
The sources of cash from banks and investors, as well as the methods of paying out cash to shareholders, are all included in the cash from financing operations.
This includes any dividends, stock repurchase payments, and loan principal repayments that the business makes.
Financing cash changes are considered “cash-in” when capital is raised and “cash-out” when any dividends are paid.
So, if a business offers a bond to the general public, it gets cash financing. However, the company’s cash is reduced when the interest is paid to bondholders. Also, keep in mind that although interest is a cash-out item, it is recorded as an operating activity rather than a financing activity.
How Cash Flow Is Calculated
Cash flow can be calculated using either direct or indirect methods.
Direct Cash Flow Method
The direct method totals all financial outlays and inflows, including cash paid to vendors, cash collected from clients, and cash received as salaries.
This CFS method is simpler for relatively small enterprises that employ the cash basis of accounting.
These figures can also be computed by comparing the net gain or reduction in the various asset and liability accounts’ beginning and ending balances.
Most businesses employ the accrual foundation of accounting. In these situations, revenue is recognized upon earning it rather than upon receipt.
Because not all transactions in net income on the income statement involve actual cash items, there is a gap between net income and actual cash flow as a result. Therefore, some things must be reevaluated while estimating cash flow from operations.
Indirect Cash Flow Method
When using the indirect technique, differences from non-cash transactions are added or subtracted from net income before calculating cash flow.
Non-cash items can be seen in the shifts in a company’s assets and liabilities from one period to the next on its balance sheet.
In order to determine an accurate cash inflow or outflow, the accountant will identify any increases and decreases in asset and liability accounts that need to be added back to or subtracted from the net income figure.
Cash flow must reflect changes in accounts receivable (AR) from one accounting period to the next on the balance sheet:
- If AR declines, additional money may have come into the business from customers paying off their credit cards; the difference between the AR decline and net earnings is then added.
- Although the amounts reflected in AR are revenue, they are not cash, so an increase in AR must be subtracted from net earnings.
Adjustments to a business’s inventory are recorded in the CFS in the following ways:
- A company's increased expenditure on raw materials is indicated by a rise in inventory. Using cash entails deducting the rise in inventory value from net profits.
- Net earnings would increase if inventories decreased. Accounts payable on the balance sheet increase due to credit purchases and the amount of the increase from one year to the next is added to net income.
Who Prepares the Statement of Cashflows?
Your accountant or bookkeeper will prepare the CFS for your business. While it is not one of the more regularly required financial statements, your financial expert will be able to create a CFS whenever you need it.
Conclusion
The statement of cash flows is an incredibly important document, particularly when looking to secure investment or determine the financial health of your business.
Did you know that a Finvisor virtual accountant or bookkeeper can produce CFS documents for you as well as take care of your day to day financial and bookkeeping tasks?
Better still, virtual financial experts cost less because you only pay for the services you need.
To find out more about virtual financial services, get in touch with the Finvisor team today.
To learn more about what we do, or to request a quote, contact us at hello@finvisor.com or 415-416-6682. We’re here to help you navigate deferred revenue journal entries so you can make the most of your assets!
*This blog does not constitute solicitation or provision of legal advice and does not establish an attorney-client relationship. This blog should not be used as a substitute for obtaining legal advice from an attorney licensed or authorized to practice in your jurisdiction.*
- Last Modified
- February 23, 2024
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