The Statement of Cash Flows is prepared using an activity format where items are classified as operating, investing, or financing activities.
A. Operating Activities
Operating activities are normal daily operating activities of running a business. The indirect method of preparing the Statement of Cash Flows adjusts the net income figure to remove noncash revenues and expenses. Also removed are items like gains and losses that are not attributable to the operating activities of the business. In considering changes in current assets and liabilities, it should be remembered that changes in notes receivable and notes payable are not shown as operating section adjustments. Changes in notes receivable is shown in the investing section, while changes in notes payable is shown in the financing section.
The general reconciliation format for the operating section is as follows:
B. Investing Activities
Buying and selling property, plant, and
equipment items are classified as investing activities. Also, all investments, (current and long-term) are classified as investing activities whether buying or selling the investment.
C. Financing Activities
Financing activities include transactions affecting long-term liabilities and stockholders' equity accounts, including the payment of cash dividends. Short-term borrowing and repaying of loans is also a financing activity. However, note that payment of interest expense is considered part of operating actitivities. Since net income is already reduced for interest expense, the only adjustment that might be required in the operating section is for changes in interest payable.
D. Significant Noncash Investing and Financing Activities
Some transactions occur that do not impact cash. These transactions are simply disclosed at the bottom of the Statement of Cash Flows as a disclosure entitled "Significant Noncash Investing and Financing Activities". An example would be the purchase of land by issuing stock.