Statement of Cash Flows - What is the Statement of Cash Flows?
Definition: The Statement of Cash Flows is a financial statement that provides an overview of the cash inflows and outflows of the business during a certain period of time.
The statement of cash flows is created in order to show a summary of the transactions that have affected the cash holdings of the organization during a certain period.
Organizing cash flow transactions
A statement of cash flows categorizes all cash transactions into one of three types of activties:
1. Operating activities: The cash inflows and outflows related to transactions which are entered in determining net income.
2. Investing activities: These transactions involve the acquisition and sale of long-term assets that are used by the organization, as well as non-operating investment assets.
3. Financing activities: These transactions include cash inflows and outflows between the business and its creditors and owners, i.e. the sale of stock for cash.
The three cash flow activity classifications prevent users of financial statements from coming to incorrect conclusions about a business, because of the total increase or decrease of cash during the accounting period.
Organizations always seek a positive cash flow, from operating activities in particular, but short-term negative cash flows from operating activities may not mean that the organization isn't doing well.
Preparing the statement: Indirect vs. the direct method
The statement of cash flows can be prepared following one of two different methods: direct or indirect.
The indirect method starts with a company’s net income and then makes adjustments for all non-cash transactions followed by adjustments from all cash transactions. A transaction that increases an asset account is subtracted from net income, while a transaction that increases a liability account is added to net income. Under the indirect method, you can convert accrual-basis net income (or loss) into cash flow through numerous additions and deductions.
The direct method more simply lists cash receipts and payments by their respective categories – cash inflows are listed as positive entries and cash outflows are listed as negative entries.