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Statement of Cash Flows

The statement of cash flows is one of the four financial statements that you are required to prepare. The statement of cash flows provides data related to all of a corporation's cash inflows and outflows for a period of time.

Cash flows are one of the most important ways to determine whether a company is solvent (can pay its debts). It is important to understand where the cash is coming from: Is the company earning it, borrowing it, or selling assets to obtain it? Obviously, this handling of cash can have serious implications.

If the company must always borrow cash to pay its bills, what is happening?

These are all issues that could cause the company to fail. Cash flow is critical for a company to be successful.

The statement of cash flows classifies the manner in which cash moves through the company. It is important to understand how transactions affect the cash account: Is there an inflow of cash, an outflow of cash, or no flow of cash?

For example, on June 1, 2016, your company has $2,200 in accounts payable (A/P). On June 5, 2016, the balance in the A/P account is $0. What happened to the cash? When A/P is reduced, it is assumed that the cash account has decreased. The company has paid the A/P, and that payment indicates a cash outflow. Cash has left the company.

If you stop to think about it, you will know what happens to the cash account when other accounts change, provided no additional accounts are impacted.

The statement of cash flows explains the difference in the cash balance at the beginning of the period and the end of the period. The cash balance on the balance sheet includes both cash and cash equivalents. Cash equivalents are investments that can be quickly converted to cash, including

• money market accounts,
• commercial paper (the company is lending money to other companies by purchasing their short-term notes), and
• U.S. Treasury bills (short-term government obligations).

The statement of cash flows has four major components: 

1. cash flows from operating activities:
   • Cash flow from operating activities explains cash inflows and outflows from normal business activities, such as selling goods or providing a service. There are two ways to calculate cash flows from operating activities:
     • the direct method, and
     • the indirect method (which you will be using).
   • This section of the statement can be confusing, since there are two ways to calculate cash flows from operating activities. Both methods will produce the same answer.
2. cash flows from investing activities:
   • This section involves cash inflows and outflows from the purchase and sale of long-term assets and from the making and collecting of long-term loans.
3. cash flows from financing activities:
   • This includes cash inflows and outflows from
     • issuance of stock (common and preferred),
     • repurchase of the company's own stock (treasury stock),
     • payment of dividends,
     • long-term borrowing, and
     • repayment of long-term debt.
4. non-cash investing and financing activities:
   • This fourth section includes such activities as issuing stock in exchange for land (where no cash was involved in the transaction).

Items that do not appear on the statement of cash flows include the purchase and resale of cash equivalents:

• money market accounts,
• commercial paper, and
• U.S. Treasury bills.