The cash flow statement details the flow of cash in and out of a business. This statement is unique among the financial statements because it records financial information as it occurs, not when revenues are earned yet not received. For example, the balance sheet and income statement both utilize the accrual method of accounting. Revenues are reported on income statements when an amount is earned, but the business may not receive the cash until the next accounting period. Expenses reported in income statements may have occurred, but not been paid yet. The cash flow statement provides a clearer picture of the funds available on hand and is presented alongside the balance sheet and income statement.
In the cash flow statement, cash inflows are positive amounts and cash outflows are negative amounts. Positive amounts include cash received and financial decisions which might positively contribute to cash on hand. Negative amounts include cash paid and financial decisions which might negatively contribute to cash on hand. The amount of change occurring in the business’s cash and cash equivalents recorded on a balance sheet should equal the net total of these positive and negative amounts. In other words, whenever cash is paid or received, the cash flow statement should reflect those changes.
The details of these inflows and outflows are reported in the operating, investing, and financing activities sections of the cash flow statement. It is also vital that the statement divulge interest and income taxes paid, and any item trades that did not involve money, such as exchanging lands or transferring stocks and bonds.
The first section, operating activities, divides cash flows into direct and indirect methods. The Financial Accounting Standards Board recommends the direct method, though this is not the preferred option for many companies.
The indirect method begins with the net income of a business to determine cash from operating activities. It first converts income statement net income from the accrual method to the cash based method of accounting in order to better reflect the flow of cash. Next, depreciation expenses are added to earnings before interest and tax, which will equal the cash from operating activities. Amortization or depletion is added to the sum, should these arise. If there are any changes made to current assets or liabilities, the net income adjusts to compensate. For example, if certain payments are not accepted but still counted, this information must be reflected. Also, if expenses are incurred but not paid for, this information must be reflected.
Investment activities make up the second component of the indirect method. This includes cash used or received from buying or selling long-term assets. Buying a long-term asset is a negative amount, while selling a long-term asset is a positive amount.
The third component of the indirect method details financing activities such as changes in short-term loans, noncurrent liabilities, and stockholders’ equity. Positive financing could be indicative of cash received from shares of stock, bonds payable, and borrowing with long or short term loans. Negative financing could be indicative of cash received from paying long or short term loan amounts or debts, buying stock, or paying dividends to stockholders.
The net totals of the three sections are balanced with changes in cash and cash equivalents as reported on the balance sheet. In a cash flow statement, the paid interest, paid income taxes, noncash investments, and financial activities must be disclosed.