What is Statement of Cash Flows?
A statement of cash flows is a financial statement that tracks changes in the balance sheet and how these changes affect a company’s cash balance. In the United States, most companies use the accrual method of accounting. This method records financial transactions as they occur, regardless of when cash changes hands between the parties involved in the transaction. The cash flow statement is used in the accrual accounting method to rectify the lack of accurate cash reporting. The cash flow statement plays an important role for the internal and external users of financial statements.
Internal financial statement users include accounting personnel, managers and company executives. The statement of cash flows gives these users the ability to see how well the company generates cash and how much cash will be needed for future uses. External users of financial statements include lenders, creditors, investors and shareholders. These individuals are interested in cash flows since they may lend or invest capital in the business as a way to generate future returns. Companies with negative cash flows usually represent a poor investment since business operations are failing to generate enough cash to pay for the business operations, let alone future returns for investors.
A statement of cash flows consists of three main sections: operating, investing and financing activities. Operating activities include the normal activities that generate or spend cash for the company. Cash from sales revenue, interest from investments, dividends from equity investments or securities, payments to vendors and payments to employees all represent operating activity cash flows.
Investing activity cash flows include the purchase of assets, loans to suppliers or customers and payments related to mergers or acquisitions. Asset purchases include land, equipment or buildings and facilities. Smaller companies may not have a lot of investing activities on the statement of cash flows since they usually do not have high capital balances for investments.
Financing activities include cash inflows received from investors, banks or shareholders. Cash outflows include dividend payments on company stock and payments on long-term liabilities or equity financing. Major loan payments or stock re-purchases are examples of financing cash outflows. Companies may use two different styles for presenting the statement of cash flows under current accounting rules.
The direct method prepares the statement by listing all major cash inflows and outflows. This method is the most common cash flow statement used by companies. It presents a detailed and informative statement for internal and external financial statement users. The indirect cash flow method starts off by listing the current net income and adjusting this figure for all cash inflows and outflows. This method is used to convert an accrual method net income statement to a cash basis method income statement.
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