cash flow statement
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In
financial accounting Financial accounting is the field of accounting Accounting or Accountancy is the measurement, processing, and communication of financial and non financial information about economic entity, economic entities such as businesses and corporat ...
, a cash flow statement, also known as ''statement of cash flows'', is a
financial statement Financial statements (or financial reports) are formal records of the financial activities and position of a business, person, or other entity. Relevant financial information is presented in a structured manner and in a form which is easy to un ...
that shows how changes in
balance sheet In financial accounting Financial accounting is the field of accounting Accounting or Accountancy is the measurement, processing, and communication of financial and non financial information about economic entity, economic entities such ...

balance sheet
accounts and income affect
cash and cash equivalents Cash and cash equivalents (CCE) are the most liquid current assets found on a business's balance sheet In financial accounting Financial accounting is the field of accounting Accounting or Accountancy is the measurement, processing, and ...
, and breaks the analysis down to operating, investing, and financing activities. Essentially, the cash flow statement is concerned with the flow of cash in and out of the business. As an analytical tool, the statement of cash flows is useful in determining the short-term viability of a company, particularly its ability to pay bills. International Accounting Standard 7 (IAS 7) is the
International Accounting Standard International Financial Reporting Standards, commonly called IFRS, are accounting standard Publicly traded companies typically are subject to the most rigorous standards. Small and midsized businesses often follow more simplified standards, plus ...
that deals with cash flow statements. People and groups interested in cash flow statements include: * Accounting personnel, who need to know whether the organization will be able to cover payroll and other immediate expenses * Potential
lender A creditor or lender is a party A party is a gathering of people who have been invited by a host A host is a person responsible for guests at an event or for providing hospitality during it. Host may also refer to: Places *Host, ...

lender
s or
creditor A creditor or lender is a party 300px, '' Hip, Hip, Hurrah!'' (1888) by Peder Severin Krøyer, a painting portraying an artists' party in 19th century Denmark A party is a gathering of people who have been invited by a host A host is ...

creditor
s, who want a clear picture of a company's ability to repay * Potential
investor An investor is a person that allocates capital with the expectation of a future financial return (profit) or to gain an advantage (interest). Through this allocated capital most of the time the investor purchases some species of property. Type ...
s, who need to judge whether the company is financially sound * Potential employees or contractors, who need to know whether the company will be able to afford compensation * Company Directors, who are responsible for the governance of the company, and are responsible for ensuring that the company does not trade while
insolvent In accounting Accounting or Accountancy is the measurement ' Measurement is the number, numerical quantification (science), quantification of the variable and attribute (research), attributes of an object or event, which can be used to comp ...
*
Shareholder A shareholder (in the United States often referred to as stockholder) of a corporation is an individual or legal entity (such as another corporation, a body politic, a Trust law, trust or partnership) that is registered by the corporation as the ...
s of the company.


Purpose

The cash flow statement was previously known as the flow of funds statement. 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 An income statement or profit and loss accountProfessional English in Use - Finance, Cambridge University Press, p. 10 (also referred to as a ''profit and loss statement'' (P&L), ''statement of profit or loss'', ''revenue statement'', ''statemen ...
summarizes a firm's financial transactions over an interval of time. These two financial statements reflect the
accrual basis accounting Accrual (''accumulation'') of something is, in finance, the adding together of interest or different investments over a period of time. It holds specific meanings in accounting, where it can refer to accounts on a balance sheet that represent liabil ...
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. 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 # provide information on a firm's
liquidity Liquidity is a concept in economics involving the convertibility of assets and obligations. It can include: * Market liquidity In business, economics or investment, market liquidity is a market's feature whereby an individual or firm can qui ...
and
solvency Solvency, in finance Finance is the study of financial institutions, financial markets and how they operate within the financial system. It is concerned with the creation and management of money and investments. Savers and investors have money ...
and its ability to change
cash flow A cash flow is a real or virtual movement of money Money is any item or verifiable record that is generally accepted as payment for goods and services and repayment of debts, such as taxes, in a particular country or socio-economic contex ...
s 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 A basis of accounting is the time various financial transactions are recorded. The cash basis (EU VAT vocabulary ''cash accounting'') and the accrual basisAccrual (''accumulation'') of something is, in finance, the adding together of interest or ...
# 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.Epstein, p. 91.


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 The Dowlais Ironworks was a major ironworks and steelworks located at Dowlais near Merthyr Tydfil, in Wales. Founded in the 18th century, it operated until the end of the 20th, at one time in the 19th century being the largest steel producer in ...
had recovered from a business slump, but had no
cash In economics Economics () is a social science Social science is the Branches of science, branch of science devoted to the study of society, societies and the Social relation, relationships among individuals within those societie ...
to invest for a new
blast furnace A blast furnace is a type of metallurgical Metallurgy is a domain of Materials science, materials science and engineering that studies the physical and chemical behavior of metallic Chemical element, elements, their Inter-metallic alloy, inter- ...
, 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 Inventory (American English American English (AmE, AE, AmEng, USEng, en-US), sometimes called United States English or U.S. English, is the set of varieties of the English language native to the United States. Currently, American English ...
. This new financial statement was the genesis of the cash flow statement that is used today. In the United States in 1973, the
Financial Accounting Standards Board The Financial Accounting Standards Board (FASB) is a private standard-setting body whose primary purpose is to establish and improve Generally Accepted Accounting Principles (GAAP) within the United States in the public's interest. The Securi ...
(FASB) defined rules that made it mandatory under
Generally Accepted Accounting Principles Publicly traded companies typically are subject to the most rigorous standards. Small and midsized businesses often follow more simplified standards, plus any specific disclosures required by their specific lenders and shareholders. Some firms oper ...
(US GAAP) to report sources and uses of funds, but the definition of "funds" was not clear.
Net working capital Working capital (abbreviated WC) is a financial metric which represents operating liquidity available to a business, organization, or other entity, including governmental entities. Along with fixed assets such as plant and equipment, working capi ...
might be cash or might be the difference between
current asset In accounting Accounting or Accountancy is the measurement ' Measurement is the number, numerical quantification (science), quantification of the variable and attribute (research), attributes of an object or event, which can be used to comp ...
s and current liabilities. From the late 1970 to the mid-1980s, the FASB discussed the usefulness of predicting future cash flows. In 1987, FASB Statement No. 95 (FAS 95) mandated that firms provide cash flow statements. 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. 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. * IAS 7 permits bank borrowings (overdraft) in certain countries to be included in cash equivalents rather than being considered a part of financing activities. * 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.Epstein, p. 93. * 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
International Accounting Standards Committee The International Accounting Standards Committee (IASC) was founded in June 1973 in London at the initiative of Henry Benson, Baron Benson, Sir Henry Benson, former president of the Institute of Chartered Accountants in England and Wales. The IASC ...
(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 Money is any item or verifiable record that is generally accepted as payment for goods and services and repayment of debts, such as taxes, in a particular country or socio-economic context. The main functions of money are distinguished as: a ...

money
going out from the business is called cash outflow.


Operating activities

Operating activities include the
production Production may refer to: Economics and business * Production (economics) Production is the process of combining various material inputs and immaterial inputs (plans, know-how) in order to make something for consumption (output). It is the act of ...
,
sales Sales are activities related to selling or the number of goods sold in a given targeted time period. The delivery of a service for a cost is also considered a sale. The seller, or the provider of the goods or services, completes a sale in ...

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: * 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 r subtracted from, as appropriatethe net income figure (which is found on the Income Statement) to arrive at cash flows from operations generally include: *
Depreciation In accountancy Accounting or Accountancy is the measurement ' Measurement is the number, numerical quantification (science), quantification of the variable and attribute (research), attributes of an object or event, which can be used to ...

Depreciation
(loss of tangible asset value over time) *
Deferred tax Deferred tax is a notional asset or liability to reflect corporate income taxation on a basis that is the same or more similar to recognition of profits than the taxation treatment. Deferred tax liabilities can arise as a result of corporate ta ...
*
Amortization Amortization (or amortisation; ) is paying off an amount owed over time by making planned, incremental payments of principal Principal may refer to: Title or rank * Principal (academia) The principal is the chief executive and the chief academ ...
(loss of
intangible asset An intangible asset is an asset In financial accounting Financial accounting is the field of accounting Accounting or Accountancy is the measurement, processing, and communication of financial and non financial information about economi ...
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 general reserves


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 * Payments related to mergers and acquisitions


Financing activities

Financing activities include the inflow of cash from
investor An investor is a person that allocates capital with the expectation of a future financial return (profit) or to gain an advantage (interest). Through this allocated capital most of the time the investor purchases some species of property. Type ...
s such as
bank A bank is a financial institution Financial institutions, otherwise known as banking institutions, are corporation A corporation is an organization—usually a group of people or a company—authorized by the State (polity), stat ...

bank
s and
shareholder A shareholder (in the United States often referred to as stockholder) of a corporation A corporation is an organization—usually a group of people or a company—authorized by the State (polity), state to act as a single entity (a legal ...
s, as well as the outflow of cash to shareholders as
dividend A dividend is a distribution of profit Profit may refer to: Business and law * Profit (accounting) Profit, in accounting Accounting or Accountancy is the measurement, processing, and communication of financial and non financial inf ...

dividend
s 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: *
Dividend A dividend is a distribution of profit Profit may refer to: Business and law * Profit (accounting) Profit, in accounting Accounting or Accountancy is the measurement, processing, and communication of financial and non financial inf ...

Dividend
s paid * Sale or repurchase of the company's
stock In finance, stock (also capital stock) consists of all of the shares In financial markets A financial market is a market in which people trade financial securities and derivatives at low transaction costs. Some of the securities i ...

stock
* Net s * Repayment of debt principal, including capital leases


Disclosure of non-cash activities

Under IAS 7, non-cash investing and financing activities are disclosed in footnotes to the financial statements. Under US General Accepted Accounting Principles (GAAP), non-cash activities may be disclosed in a footnote or within the cash flow statement itself. Non-cash financing activities may include * Leasing to purchase an asset * Converting debt to equity * Exchanging non-cash assets or liabilities for other non-cash assets or liabilities * Issuing share * Payment of dividend taxes in exchange for assets


Preparation methods

The direct method of preparing a cash flow statement results in a more easily understood report. 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.


Direct method

The direct method for creating a cash flow statement reports major classes of gross cash receipts and payments. Under IAS 7, dividends received may be reported under operating activities or under investing activities. If taxes paid are directly linked to operating activities, they are reported under operating activities; if the taxes are directly linked to investing activities or financing activities, they are reported under investing or financing activities. Generally Accepted Accounting Principles (GAAP) vary from International Financial Reporting Standards in that under GAAP rules, dividends received from a company's investing activities is reported as an "operating activity," not an "investing activity." Sample cash flow statement using the direct method


Indirect method

The indirect method uses net-income as a starting point, makes adjustments for all transactions for non-cash items, then adjusts from all cash-based transactions. An increase in an asset account is subtracted from net income, and an increase in a liability account is added back to net income. This method converts accrual-basis net income (or loss) into cash flow by using a series of additions and deductions.


Rules (operating activities)

The following rules can be followed to calculate Cash Flows from Operating Activities when given only a two-year comparative balance sheet and the Net Income figure. Cash Flows from Operating Activities can be found by adjusting Net Income relative to the change in beginning and ending balances of Current Assets, Current Liabilities, and sometimes Long Term Assets. When comparing the change in long term assets over a year, the accountant must be certain that these changes were caused entirely by their devaluation rather than purchases or sales (i.e. they must be operating items not providing or using cash) or if they are non-operating items. *Decrease in non-cash current assets are added to net income *Increase in non-cash current asset are subtracted from net income *Increase in current liabilities are added to net income *Decrease in current liabilities are subtracted from net income *Expenses with no cash outflows are added back to net income (depreciation and/or amortization expense are the only operating items that have no effect on cash flows in the period) *Revenues with no cash inflows are subtracted from net income *Non operating losses are added back to net income *Non operating gains are subtracted from net income The intricacies of this procedure might be seen as, \text = \text + \text For example, consider a company that has a net income of $100 this year, and its A/R increased by $25 since the beginning of the year. If the balances of all other current assets, long term assets and current liabilities did not change over the year, the cash flows could be determined by the rules above as $100 – $25 = Cash Flows from Operating Activities = $75. The logic is that, if the company made $100 that year (net income), and they are using the accrual accounting system (not cash based) then any income they generated that year which has not yet been paid for in cash should be subtracted from the net income figure in order to find cash flows from operating activities. And the increase in A/R meant that $25 of sales occurred on credit and have not yet been paid for in cash. In the case of finding Cash Flows when there is a change in a fixed asset account, say the Buildings and Equipment account decreases, the change is added back to Net Income. The reasoning behind this is that because Net Income is calculated by, Net Income = Rev - Cogs - Depreciation Exp - Other Exp then the Net Income figure will be decreased by the building's depreciation that year. This depreciation is not associated with an exchange of cash, therefore the depreciation is added back into net income to remove the non-cash activity.


Rules (financing activities)

Finding the Cash Flows from Financing Activities is much more intuitive and needs little explanation. Generally, the things to account for are financing activities: *Include as outflows, reductions of long term notes payable (as would represent the cash repayment of debt on the balance sheet) *Or as inflows, the issuance of new notes payable *Include as outflows, all dividends paid by the entity to outside parties *Or as inflows, dividend payments received from outside parties *Include as outflows, the purchase of notes stocks or bonds *Or as inflows, the receipt of payments on such financing vehicles. In the case of more advanced accounting situations, such as when dealing with subsidiaries, the accountant must *Exclude intra-company dividend payments. *Exclude intra-company bond interest. A traditional equation for this might look something like, :\begin\text = & \left text3^\text\right\ & -\left text3^\text\right\ & - [\text \\ & \text] \end Example: cash flow of XYZ:Bodie, p. 455.


See also

*Cash flow *Income statement *Balance sheet *statement of changes in equity


Notes and references

{{authority control Cash flow Financial statements Accounting terminology