Business, Legal & Accounting Glossary
Provides information about changes in financial position. The cash flow or flow of funds statement shows how an operation has been financed in the latest accounting period and how resources have been used.
The balance sheet, income statement, and cash flow statement are the three generally accepted financial statements used by most businesses for financial reporting. All three statements are prepared from the same accounting data, but each statement serves its own purpose. The purpose of the cash flow statement is to report how much cash went into and out of a company during a specific time frame like a quarter or a year. In other words, it shows how much cash a company is generating from one period to the next. It shows how changes in balance sheet accounts and income affect cash and cash equivalents, and breaks the analysis down to operating, investing, and financing activities.
As an analytical tool, the statement of cash flows is an indicator of a company’s financial strength. It is useful in determining the short-term viability of a company, particularly its ability to pay bills. The statement of cash flows strips out all the abstract, noncash revenues, and expenses that are included in the income statement. Many companies have shown profits on the income statement but have stumbled later because of insufficient cash flows.
Companies can generate cash in several different ways. The cash flow statement organizes and reports the cash generated and used in the following categories:
Two different methods used for preparing a Cash Flow Statement can be explained as follows
The direct method of preparing a cash flow statement results in a more easily understood report. Under the direct method, cash and bank accounts are analyzed to identify cash flows during the period. A detailed general ledger report showing all the entries to the cash and bank accounts are used. The cash receipts and disbursements journals may also be used for the purpose. The offsetting entry for each cash entry is then determined in order to decide where each cash movement should be reported on the cash flow statement.
Another way to determine cash flows under the direct method is to prepare a worksheet for each major line item, and eliminate the effects of accrual basis accounting in order to arrive at the net cash effect for that particular line item for the period. For example, the operating activities section may include:
Similar types of calculations can be made of the balance sheet accounts to eliminate the effects of accrual accounting and determine the cash flows to be reported in the investing activities and financing activities sections of the cash flow statement.
|Cash flows from (used in) operating activities|
|Cash receipts from customers||27,000|
|Cash paid to suppliers and employees||(20,000)|
|Cash generated from operations (sum)||7,000|
|Income taxes paid||(4,000)|
|Net cash flows from operating activities||1,000|
|Cash flows from (used in) investing activities|
|Proceeds from the sale of equipment||7,000|
|Net cash flows from investing activities||10,000|
|Cash flows from (used in) financing activities|
|Net cash flows used in financing activities||(2,000)|
|Net increase in cash and cash equivalents||9,000|
|Cash and cash equivalents, beginning of year||1,000|
|Cash and cash equivalents, end of year||$10,000|
The indirect method is almost universally used, because FAS 95 requires a supplementary report similar to the indirect method if a company chooses to use the direct method. It uses net-income as a starting point, makes adjustments for all transactions for non-cash items, then adjusts for all cash-based transactions. Entries that affect net income but do not represent cash flows could include income you have earned but not yet received, amortization of prepaid expenses, accrued expenses, and depreciation or amortization. This method converts accrual-basis net income (or loss) into cash flow by using a series of additions and deductions. An increase in an asset account is subtracted from net income, and an increase in a liability account is added back to net income. The following is an example of how the indirect method would be presented on the cash flow statement:
Net income per the income statement
Minus entries to income accounts that do not represent cash flows
Plus entries to expense accounts that do not represent cash flows
Equals cash flows before movements in working capital
Plus or minus the change in working capital, as follows:
Current assets (excluding cash and cash equivalents) may include things like inventories and accounts receivable, while current liabilities (excluding short-term debt which would be reported in the financing activities section) would include deferred taxes and accounts payable.
The net effect of the above would then be reported as cash provided by (used in) operating activities.
The cash flows from investing activities and financing activities would be presented the same way as under the direct method.
The cash from operating activities is compared to the company’s net income. If the cash from operating activities is consistently greater than the net income, the company’s net income or earnings are said to be of a “high quality”. If the cash from operating activities is less than net income, a red flag is raised as to why the reported net income is not turning into cash.
|Operating activities, cash flows provided by or used in:|
|Depreciation and amortization||2,300|
|Adjustments to net income||4,600|
|Decrease (increase) in accounts receivable||12,500|
|Increase (decrease) in liabilities (A/P, taxes payable)||131,600|
|Decrease (increase) in inventories||–|
|Increase (decrease) in other operating activities||(143,000)|
|Net cash flow from operating activities||8,000|
|Investing activities, cash flows provided by or used in:|
|Other cash flows from investing activities||1,000|
|Net cash flows from investing activities||(204,000)|
|Financing activities, cash flows provided by or used in:|
|Sale (repurchase) of stock||(6,000)|
|Increase (decrease) in debt||101,000|
|Other cash flows from financing activities||120,000|
|Net cash flows from financing activities||206,000|
|Net increase (decrease) in cash and cash equivalents||$10,000|
statement of cash flows
consolidated statement of cash flows
A company’s cash flow statement provides an overview of all cash-related activities for a given period of time. It includes operating activities such as depreciation and changes in liabilities, investing activities such as capital expenditures, and activities such as paying dividends or buying or selling stock.
“Follow the money.” You’ll hear TV detectives say this all the time, when they’re tracking down someone who might benefit from a crime. But it’s equally important to you when you want to keep track of a business’s performance.
The cash flow statement shows you, the investor or analyst, how cash is moving through a business. It reconciles net income, which is a non-cash GAAP number, with the actual cash coming into or leaving the business. It shows what the company is doing with its cash; where that cash is from; and how much of it stays within the business at the end of the reporting period.
On this statement, any negative number is cash flowing out of the business (such as buying inventory), while any positive number is cash flowing into the business (such as taking out a loan).
Given an income statement and a balance sheet, it is possible to construct the cash flow statement.
Important point: Interim cash flow statements — those reported between either end of the company’s fiscal year, such as in the second or third quarter — are cumulative from the end of the previous year. In order to determine the various cash flows for that quarter alone, you’ll need to subtract the figures from the previous quarter’s statement.
The cash flow statement is broken down into three sections, which are always presented in this order:
This is presented in two different ways. The indirect method, followed by most U.S. companies, begins with net income. The direct method, followed by many foreign companies, begins with revenue.
For this presentation, this section begins with net income and then adjusts for any and all non-cash income or expenses, ending with cash flow from operations. Adjustments include the following:
Depending on the nature of the item or the direction of the change in the balance sheet accounts, these items are either added or subtracted to net income. After all of that, you are left with net cash from operating activities.
Beginning with revenue, this method adds or subtracts all cash expenses (such as salary payments, inventory purchases, or cash receipts from accounts receivable). It ends up at net cash from operating activities. This will be the same amount found by using the indirect method. In fact, if a company reports using the direct method, it must also supply the indirect method as a supplementary report (FAS 95).
This section shows all the cash the business spent on or received from investments. You will see things like capital expenditures, purchase (or sale) of marketable securities, and acquisitions of other businesses.
This section details how the company is raising additional cash (such as from debt or issuing stock) as well as sharing cash with investors (paying dividend) or using cash to pay back debt or for share repurchase. Adding all that up we are left with net cash from financing activities.
The net cash from all three sections are then added up to calculate the net change in cash which reflects the change in cash and equivalents on the balance sheet.
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This glossary post was last updated: 28th November, 2021 | 8 Views.