The statement of cash flows is part of the financial statements issued by a business, and describes the cash flows into and out of the organization. Its particular focus is on the types of activities that create and use cash, which are operations, investments, and financing. Though the statement of cash flows is generally considered less critical than the income statement and balance sheet, it can be used to discern trends in business performance that are not readily apparent in the rest of the financial statements. It is especially useful when there is a divergence between the amount of profits reported and the amount of net cash flow generated by operations.
There can be significant differences between the results shown in the income statement and the cash flows in this statement, for the following reasons:
- There are timing differences between the recordation of a transaction and when the related cash is actually expended or received.
- 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 (i.e. most difficult to fudge), 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:
activities. These constitute the revenue-generating activities of a business. Examples of operating activities are cash received and disbursed for product sales, royalties, commissions, fines, lawsuits, supplier and lender invoices, and payroll.
- Investing activities. These constitute payments made to acquire long-term assets, as well as cash received from their sale. Examples of investing activities are the purchase of fixed assets and the purchase or sale of securities issued by other entities.
- Financing activities. These constitute activities that will alter the equity or borrowings of a business. Examples are the sale of company shares, the repurchase of shares, and dividend payments.
There are two ways in which to present the statement of cash flows, which are the direct method and the indirect method. The direct method requires you to present cash flow information that is directly associated with the items triggering cash flows, such as:
- Cash collected from customers
- Interest and dividends received
- Cash paid to employees
- Cash paid to suppliers
- Interest paid
- Income taxes paid
Few organization collect information as required for the direct method, so they instead use the indirect method. Under the indirect approach, the statement begins with the net income or loss reported on the company's income statement, and then makes a series of adjustments to this figure to arrive at the amount of net cash provided by operating activities. The following links provide more information about the direct method and indirect method.
The statement of cash flows is also known as the cash flow statement .