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Cash Flow Statement

What is Cash Flow Statement?

How to Prepare a Cash Flow Statement

The basic aim behind preparing cash flow statement, an important part of financial statements, is to track the incoming and outgoing flow of cash to and from the company. It keeps records of those activities that generate as well as use finances of the company such as operations, financing and investments. Although not as imperative as the income statement and balance sheet, cash flow statements generally helps in figuring out trends, that the business is following, which are not easily discernible. The main use of cash flow statements comes when there is visible difference between amount of total cash generated by operations and the amount of profits showcased.

Significant differences between the results shown may arise in the income statement and the cash flows in this statement, for the following reasons:

• There are time gap between the recordation of a transaction and when the related cash is expended or received actually.

• Management may be using aggressive revenue recognition to report revenue for which cash receipts are still some time in the future.

• The business may be asset intensive, and so requires large capital investments that do not appear in the income statement, except on a delayed basis as depreciation.

Many investors feel that the statement of cash flows is the most transparent of the financial statements and so they tend to rely upon it more than the other financial statements to discern the true performance of a business.

Cash flows in the statement are divided into the following three areas:

• Operating activities: Operating activities comprise of revenue-generating activities of a business. Examples: cash received and disbursed for product sales, royalties, commissions, fines, lawsuits, supplier and lender invoices, and payroll.

• Investing activities: Investing activities includes payments that are made to acquire long-term assets and cash received from their sale. Examples: purchase of fixed assets and the purchase or sale of securities issued by other entities.

• Financing activities: The financial activities comprise equity or borrowings that will alter the business. Examples: sale of company shares, the repurchase of shares and dividend payments. There are mainly two ways in which to present the statement of cash flows: the direct method and the indirect method.

    Direct method

    The direct method of presenting the statement of cash flows presents the specific cash flows associated with items that affect cash flow. The items include:

  • • Cash collected from customers

  • • Interest and dividends received

  • • Cash paid to employees

  • • Cash paid to suppliers

  • • Interest paid

  • • Income taxes paid.

  • The advantage of the direct method over the indirect method is that it reveals operating cash receipts and payments.

    Indirect method

    The presentation of statement of cash in indirect method begins with net income or loss, with subsequent additions to or deductions from that amount for non-cash revenue and expense items, resulting in net income provided by operating activities. The indirect method of presentation is very popular because the information required for it is relatively easily assembled from the accounts that a business normally maintains in its chart of accounts.

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