Cash flow statement
Encyclopedia
In financial accounting, a cash flow statement, also known as statement of cash flows or funds flow statement, is a financial statement
that shows how changes in balance sheet
accounts and income affect cash and cash equivalents
, and breaks the analysis down to operating, investing, and financing activities. Essentially, the cash flow statement is concerned with the flow of cash in and cash out of the business. The statement captures both the current operating results and the accompanying changes in the balance sheet
. As an analytical tool, the statement of cash flows is useful in determining the short-term viability of a company, particularly its ability to pay bills. International Accounting Standard 7 (IAS 7), is the International Accounting Standard that deals with cash flow statements.
People and groups interested in cash flow statements include:
The cash flow statement was previously known as the flow of Cash statement. The cash flow statement reflects a firm's liquidity.
The balance sheet is a snapshot of a firm's financial resources and obligations at a single point in time, and the income statement summarizes a firm's financial transactions over an interval of time. These two financial statements reflect the accrual basis accounting used by firms to match revenues with the expenses associated with generating those revenues. The cash flow statement includes only inflows and outflows of cash and cash equivalents; it excludes transactions that do not directly affect cash receipts and payments. These non-cash transactions include depreciation or write-offs on bad debts or credit losses to name a few. The cash flow statement is a cash basis report on three types of financial activities: operating activities, investing activities, and financing activities. Non-cash activities are usually reported in footnotes.
The cash flow statement is intended to
The cash flow statement has been adopted as a standard financial statement because it eliminates allocations, which might be derived from different accounting methods, such as various timeframes for depreciating fixed assets.
In 1863, the Dowlais Iron Company had recovered from a business slump, but had no cash
to invest for a new blast furnace
, despite having made a profit. To explain why there were no funds to invest, the manager made a new financial statement that was called a comparison balance sheet, which showed that the company was holding too much inventory
. This new financial statement was the genesis of Cash Flow Statement that is used today.
In the United States in 1971, the Financial Accounting Standards Board
(FASB) defined rules that made it mandatory under Generally Accepted Accounting Principles (US GAAP) to report sources and uses of funds, but the definition of "funds" was not clear."Net working capital" might be cash or might be the difference between current asset
s and current liabilities. From the late 1970 to the mid-1980s, the FASB discussed the usefulness of predicting future cash flows. In 1987, FASB Statement No. 95 (FAS 95) mandated that firms provide cash flow statements. In 1992, the International Accounting Standards Board issued
International Accounting Standard 7 (IAS 7), Cash Flow Statements, which became effective in 1994, mandating that firms provide cash flow statements.
US GAAP and IAS 7 rules for cash flow statements are similar, but some of the differences are:
1) cash flow resulting from operating activities;
2) cash flow resulting from investing activities;and
3) cash flow resulting from financing activities.
The money coming into the business is called cash inflow, and money
going out from the business is called cash outflow.
, sales
and delivery of the company's product as well as collecting payment from its customers. This could include purchasing raw materials, building inventory, advertising, and shipping the product.
Under IAS 7, operating cash flows include:
Items which are added back to [or subtracted from, as appropriate] the net income figure (which is found on the Income Statement) to arrive at cash flows from operations generally include:
s such as bank
s and shareholder
s, as well as the outflow of cash to shareholders as dividend
s as the company generates income. Other activities which impact the long-term liabilities and equity of the company are also listed in the financing activities section of the cash flow statement.
Under IAS 7,
Items under the financing activities section include:
Sample cash flow statement using the direct method
The following rules can be followed to calculate Cash Flows from Operating Activities when given only a two year comparative balance sheet and the Net Income figure. Cash Flows from Operating Activities can be found by adjusting Net Income relative to the change in beginning and ending balances of Current Assets, Current Liabilities, and sometimes Long Term Assets. When comparing the change in long term assets over a year, the accountant must be certain that these changes were caused entirely by their devaluation rather than purchases or sales (i.e. they must be operating items not providing or using cash) or if they are nonoperating items.
The intricacies of this procedure might be seen as,
For example, consider a company that has a net income of $100 this year, and its A/R increased by $25 since the beginning of the year. If the balances of all other current assets, long term assets and current liabilities did not change over the year, the cash flows could be determined by the rules above as $100 – $25 = Cash Flows from Operating Activities = $75. The logic is that, if the company made $100 that year (net income), and they are using the accrual accounting system (not cash based) then any income they generated that year which has not yet been paid for in cash should be subtracted from the net income figure in order to find cash flows from operating activities. And the increase in A/R meant that $25 of sales occurred on credit and have not yet been paid for in cash.
In the case of finding Cash Flows when there is a change in a fixed asset account, say the Buildings and Equipment account decreases, the change is added back to Net Income. The reasoning behind this is that because Net Income is calculated by, Net Income = Rev - Cogs - Depreciation Exp - Other Exp then the Net Income figure will be decreased by the building's depreciation that year. This depreciation is not associated with an exchange of cash, therefore the depreciation is added back into net income to remove the non-cash activity.
In the case of more advanced accounting situations, such as when dealing with subsidiaries, the accountant must
A traditional equation for this might look something like,
Example: cash flow of XYZ
:
Financial statements
A financial statement is a formal record of the financial activities of a business, person, or other entity. In British English—including United Kingdom company law—a financial statement is often referred to as an account, although the term financial statement is also used, particularly by...
that shows how changes in balance sheet
Balance sheet
In financial accounting, a balance sheet or statement of financial position is a summary of the financial balances of a sole proprietorship, a business partnership or a company. Assets, liabilities and ownership equity are listed as of a specific date, such as the end of its financial year. A...
accounts and income affect cash and cash equivalents
Cash and cash equivalents
Cash and cash equivalents are the most liquid assets found within the asset portion of a company's balance sheet. Cash equivalents are assets that are readily convertible into cash, such as money market holdings, short-term government bonds or Treasury bills, marketable securities and commercial...
, and breaks the analysis down to operating, investing, and financing activities. Essentially, the cash flow statement is concerned with the flow of cash in and cash out of the business. The statement captures both the current operating results and the accompanying changes in the balance sheet
Balance sheet
In financial accounting, a balance sheet or statement of financial position is a summary of the financial balances of a sole proprietorship, a business partnership or a company. Assets, liabilities and ownership equity are listed as of a specific date, such as the end of its financial year. A...
. As an analytical tool, the statement of cash flows is useful in determining the short-term viability of a company, particularly its ability to pay bills. International Accounting Standard 7 (IAS 7), is the International Accounting Standard that deals with cash flow statements.
People and groups interested in cash flow statements include:
- Accounting personnel, who need to know whether the organization will be able to cover payroll and other immediate expenses
- Potential lenders or creditorCreditorA creditor is a party that has a claim to the services of a second party. It is a person or institution to whom money is owed. The first party, in general, has provided some property or service to the second party under the assumption that the second party will return an equivalent property or...
s, who want a clear picture of a company's ability to repay - Potential investorInvestorAn investor is a party that makes an investment into one or more categories of assets --- equity, debt securities, real estate, currency, commodity, derivatives such as put and call options, etc...
s, who need to judge whether the company is financially sound - Potential employees or contractors, who need to know whether the company will be able to afford compensation
- ShareholderShareholderA shareholder or stockholder is an individual or institution that legally owns one or more shares of stock in a public or private corporation. Shareholders own the stock, but not the corporation itself ....
s of the business.
Purpose
| Statement of Cash Flow - Simple Example for the period 01/01/2006 to 12/31/2006 |
|
|---|---|
| Cash flow from operations | $4,000 |
| Cash flow from investing | ($1,000) |
| Cash flow from financing | ($2,000) |
| Net cash flow | $1,000 |
| Parentheses indicate negative values | |
The cash flow statement was previously known as the flow of Cash statement. The cash flow statement reflects a firm's liquidity.
The balance sheet is a snapshot of a firm's financial resources and obligations at a single point in time, and the income statement summarizes a firm's financial transactions over an interval of time. These two financial statements reflect the accrual basis accounting used by firms to match revenues with the expenses associated with generating those revenues. The cash flow statement includes only inflows and outflows of cash and cash equivalents; it excludes transactions that do not directly affect cash receipts and payments. These non-cash transactions include depreciation or write-offs on bad debts or credit losses to name a few. The cash flow statement is a cash basis report on three types of financial activities: operating activities, investing activities, and financing activities. Non-cash activities are usually reported in footnotes.
The cash flow statement is intended to
- provide information on a firm's liquidityMarket liquidityIn business, economics or investment, market liquidity is an asset's ability to be sold without causing a significant movement in the price and with minimum loss of value...
and solvencySolvencySolvency, in finance or business, is the degree to which the current assets of an individual or entity exceed the current liabilities of that individual or entity. Solvency can also be described as the ability of a corporation to meet its long-term fixed expenses and to accomplish long-term...
and its ability to change cash flowCash flowCash flow is the movement of money into or out of a business, project, or financial product. It is usually measured during a specified, finite period of time. Measurement of cash flow can be used for calculating other parameters that give information on a company's value and situation.Cash flow...
s in future circumstances - provide additional information for evaluating changes in assets, liabilities and equity
- improve the comparability of different firms' operating performance by eliminating the effects of different accounting methods
- indicate the amount, timing and probability of future cash flows
The cash flow statement has been adopted as a standard financial statement because it eliminates allocations, which might be derived from different accounting methods, such as various timeframes for depreciating fixed assets.
History & variations
Cash basis financial statements were very common before accrual basis financial statements. The "flow of funds" statements of the past were cash flow statements.In 1863, the Dowlais Iron Company had recovered from a business slump, but had no cash
Cash
In common language cash refers to money in the physical form of currency, such as banknotes and coins.In bookkeeping and finance, cash refers to current assets comprising currency or currency equivalents that can be accessed immediately or near-immediately...
to invest for a new blast furnace
Blast furnace
A blast furnace is a type of metallurgical furnace used for smelting to produce industrial metals, generally iron.In a blast furnace, fuel and ore and flux are continuously supplied through the top of the furnace, while air is blown into the bottom of the chamber, so that the chemical reactions...
, despite having made a profit. To explain why there were no funds to invest, the manager made a new financial statement that was called a comparison balance sheet, which showed that the company was holding too much inventory
Inventory
Inventory means a list compiled for some formal purpose, such as the details of an estate going to probate, or the contents of a house let furnished. This remains the prime meaning in British English...
. This new financial statement was the genesis of Cash Flow Statement that is used today.
In the United States in 1971, the Financial Accounting Standards Board
Financial Accounting Standards Board
The Financial Accounting Standards Board is a private, not-for-profit organization whose primary purpose is to develop generally accepted accounting principles within the United States in the public's interest...
(FASB) defined rules that made it mandatory under Generally Accepted Accounting Principles (US GAAP) to report sources and uses of funds, but the definition of "funds" was not clear."Net working capital" might be cash or might be the difference between current asset
Current asset
In accounting, a current asset is an asset on the balance sheet which can either be converted to cash or used to pay current liabilities within 12 months...
s and current liabilities. From the late 1970 to the mid-1980s, the FASB discussed the usefulness of predicting future cash flows. In 1987, FASB Statement No. 95 (FAS 95) mandated that firms provide cash flow statements. In 1992, the International Accounting Standards Board issued
International Accounting Standard 7 (IAS 7), Cash Flow Statements, which became effective in 1994, mandating that firms provide cash flow statements.
US GAAP and IAS 7 rules for cash flow statements are similar, but some of the differences are:
- IAS 7 requires that the cash flow statement include changes in both cash and cash equivalents. US GAAP permits using cash alone or cash and cash equivalents.
- IAS 7 permits bank borrowings (overdraft) in certain countries to be included in cash equivalents rather than being considered a part of financing activities.
- IAS 7 allows interest paid to be included in operating activities or financing activities. US GAAP requires that interest paid be included in operating activities.
- US GAAP (FAS 95) requires that when the direct method is used to present the operating activities of the cash flow statement, a supplemental schedule must also present a cash flow statement using the indirect method. The IASC strongly recommends the direct method but allows either method. The IASC considers the indirect method less clear to users of financial statements. Cash flow statements are most commonly prepared using the indirect method, which is not especially useful in projecting future cash flows.
Cash flow activities
The cash flow statement is partitioned into three segments, namely:1) cash flow resulting from operating activities;
2) cash flow resulting from investing activities;and
3) cash flow resulting from financing activities.
The money coming into the business is called cash inflow, and money
Money
Money is any object or record that is generally accepted as payment for goods and services and repayment of debts in a given country or socio-economic context. The main functions of money are distinguished as: a medium of exchange; a unit of account; a store of value; and, occasionally in the past,...
going out from the business is called cash outflow.
Operating activities
Operating activities include the productionProduction, costs, and pricing
The following outline is provided as an overview of and topical guide to industrial organization:Industrial organization – describes the behavior of firms in the marketplace with regard to production, pricing, employment and other decisions...
, sales
Sales
A sale is the act of selling a product or service in return for money or other compensation. It is an act of completion of a commercial activity....
and delivery of the company's product as well as collecting payment from its customers. This could include purchasing raw materials, building inventory, advertising, and shipping the product.
Under IAS 7, operating cash flows include:
- Receipts from the sale of goods or services
- Receipts for the sale of loans, debt or equity instruments in a trading portfolio
- Interest received on loans
- Dividends received on equity securities
- Payments to suppliers for goods and services
- Payments to employees or on behalf of employees
- Interest payments (alternatively, this can be reported under financing activities in IAS 7, and US GAAP)
- buying Merchandise
Items which are added back to [or subtracted from, as appropriate] the net income figure (which is found on the Income Statement) to arrive at cash flows from operations generally include:
- DepreciationDepreciationDepreciation refers to two very different but related concepts:# the decrease in value of assets , and# the allocation of the cost of assets to periods in which the assets are used ....
(loss of tangible asset value over time) - Deferred taxDeferred taxDeferred tax is an accounting concept , meaning a future tax liability or asset, resulting from temporary differences or timing differences between the accounting value of assets and liabilities and their value for tax purposes.- Temporary differences :Temporary differences are differences between...
- Amortization (loss of intangible asset value over time)
- Any gains or losses associated with the sale of a non-current asset, because associated cash flows do not belong in the operating section.(unrealized gains/losses are also added back from the income statement)
Investing activities
Examples of Investing activities are- Purchase or Sale of an asset (assets can be land, building, equipment, marketable securities, etc.)
- Loans made to suppliers or received from customers
- Payments related to mergers and acquisitions
Financing activities
Financing activities include the inflow of cash from investorInvestor
An investor is a party that makes an investment into one or more categories of assets --- equity, debt securities, real estate, currency, commodity, derivatives such as put and call options, etc...
s such as bank
Bank
A bank is a financial institution that serves as a financial intermediary. The term "bank" may refer to one of several related types of entities:...
s and shareholder
Shareholder
A shareholder or stockholder is an individual or institution that legally owns one or more shares of stock in a public or private corporation. Shareholders own the stock, but not the corporation itself ....
s, as well as the outflow of cash to shareholders as dividend
Dividend
Dividends are payments made by a corporation to its shareholder members. It is the portion of corporate profits paid out to stockholders. When a corporation earns a profit or surplus, that money can be put to two uses: it can either be re-invested in the business , or it can be distributed to...
s as the company generates income. Other activities which impact the long-term liabilities and equity of the company are also listed in the financing activities section of the cash flow statement.
Under IAS 7,
- Proceeds from issuing short-term or long-term debt
- Payments of dividends
- Payments for repurchase of company shares
- Repayment of debt principal, including capital leases
- For non-profit organizations, receipts of donor-restricted cash that is limited to long-term purposes
Items under the financing activities section include:
- Dividends paid
- Sale or repurchase of the company's stockStockThe capital stock of a business entity represents the original capital paid into or invested in the business by its founders. It serves as a security for the creditors of a business since it cannot be withdrawn to the detriment of the creditors...
- Net borrowingDebtA debt is an obligation owed by one party to a second party, the creditor; usually this refers to assets granted by the creditor to the debtor, but the term can also be used metaphorically to cover moral obligations and other interactions not based on economic value.A debt is created when a...
s - Payment of dividend tax
Disclosure of non-cash activities
Under IAS 7, non-cash investing and financing activities are disclosed in footnotes to the financial statements. Under US General Accepted Accounting Principles (GAAP), non-cash activities may be disclosed in a footnote or within the cash flow statement itself. Non-cash financing activities may include- Leasing to purchase an asset
- Converting debt to equity
- Exchanging non-cash assets or liabilities for other non-cash assets or liabilities
- Issuing shares in exchange for assets
Preparation methods
The direct method of preparing a cash flow statement results in a more easily understood report. The indirect method is almost universally used, because FAS 95 requires a supplementary report similar to the indirect method if a company chooses to use the direct method.Direct method
The direct method for creating a cash flow statement reports major classes of gross cash receipts and payments. Under IAS 7, dividends received may be reported under operating activities or under investing activities. If taxes paid are directly linked to operating activities, they are reported under operating activities; if the taxes are directly linked to investing activities or financing activities, they are reported under investing or financing activities.Sample cash flow statement using the direct method
| Cash flows from (used in) operating activities | ||
| Cash receipts from customers | 9,500 | |
| Cash paid to suppliers and employees | (2,000) | |
| Cash generated from operations (sum) | 7,500 | |
| Interest paid | (2,000) | |
| Income taxes paid | (3,000) | |
| Net cash flows from operating activities | 2,500 | |
| Cash flows from (used in) investing activities | ||
| Proceeds from the sale of equipment | 7,500 | |
| Dividends received | 3,000 | |
| Net cash flows from investing activities | 10,500 | |
| Cash flows from (used in) financing activities | ||
| Dividends paid | (2,500) | |
| Net cash flows used in financing activities | (2,500) | |
| . | ||
| Net increase in cash and cash equivalents | 10,500 | |
| Cash and cash equivalents, beginning of year | 1,000 | |
| Cash and cash equivalents, end of year | $11,500 | |
Indirect method
The indirect method uses net-income as a starting point, makes adjustments for all transactions for non-cash items, then adjusts from all cash-based transactions. An increase in an asset account is subtracted from net income, and an increase in a liability account is added back to net income. This method converts accrual-basis net income (or loss) into cash flow by using a series of additions and deductions.Rules (Operating Activities)
| To Find Cash Flows from Operating Activities using the Balance Sheet and Net Income |
|
|---|---|
| For Increases in | Net Inc Adj |
| Current Assets (Non-Cash) | Decrease |
| Current Liabilities | Increase |
| For All Non-Cash... | |
| *Expenses (Decreases in Fixed Assets) | Increase |
The following rules can be followed to calculate Cash Flows from Operating Activities when given only a two year comparative balance sheet and the Net Income figure. Cash Flows from Operating Activities can be found by adjusting Net Income relative to the change in beginning and ending balances of Current Assets, Current Liabilities, and sometimes Long Term Assets. When comparing the change in long term assets over a year, the accountant must be certain that these changes were caused entirely by their devaluation rather than purchases or sales (i.e. they must be operating items not providing or using cash) or if they are nonoperating items.
- Decrease in non-cash current assets are added to net income
- Increase in non-cash current asset are subtracted from net income
- Increase in current liabilities are added to net income
- Decrease in current liabilities are subtracted from net income
- Expenses with no cash outflows are added back to net income (depreciation and/or amortization expense are the only operating items that have no effect on cash flows in the period)
- Revenues with no cash inflows are subtracted from net income
- Non operating losses are added back to net income
- Non operating gains are subtracted from net income
The intricacies of this procedure might be seen as,
For example, consider a company that has a net income of $100 this year, and its A/R increased by $25 since the beginning of the year. If the balances of all other current assets, long term assets and current liabilities did not change over the year, the cash flows could be determined by the rules above as $100 – $25 = Cash Flows from Operating Activities = $75. The logic is that, if the company made $100 that year (net income), and they are using the accrual accounting system (not cash based) then any income they generated that year which has not yet been paid for in cash should be subtracted from the net income figure in order to find cash flows from operating activities. And the increase in A/R meant that $25 of sales occurred on credit and have not yet been paid for in cash.
In the case of finding Cash Flows when there is a change in a fixed asset account, say the Buildings and Equipment account decreases, the change is added back to Net Income. The reasoning behind this is that because Net Income is calculated by, Net Income = Rev - Cogs - Depreciation Exp - Other Exp then the Net Income figure will be decreased by the building's depreciation that year. This depreciation is not associated with an exchange of cash, therefore the depreciation is added back into net income to remove the non-cash activity.
Rules (Financing Activities)
Finding the Cash Flows from Financing Activities is much more intuitive and needs little explanation. Generally, the things to account for are financing activities:- Include as outflows, reductions of long term notes payable (as would represent the cash repayment of debt on the balance sheet)
- Or as inflows, the issuance of new notes payable
- Include as outflows, all dividends paid by the entity to outside parties
- Or as inflows, dividend payments received from outside parties
- Include as outflows, the purchase of notes stocks or bonds
- Or as inflows, the receipt of payments on such financing vehicles.
In the case of more advanced accounting situations, such as when dealing with subsidiaries, the accountant must
- Exclude intra-company dividend payments.
- Exclude intra-company bond interest.
A traditional equation for this might look something like,
Example: cash flow of XYZ
XYZ
XYZ may refer to:* Cartesian coordinate system * CIE 1931 color space, color coordinates called "XYZ"* XYZ file format, a chemical file format* XYZ , an abortive rock project featuring Jimmy Page, Chris Squire and Alan White...
:
| XYZ co. Ltd. Cash Flow Statement (all numbers in millions of Rs.) |
|||
| Period ending | 03/31/2010 | 03/31/2009 | 03/31/2008 |
| Net income | 21,538 | 24,589 | 17,046 |
| Operating activities, cash flows provided by or used in: | |||
| Depreciation and amortization | 2,790 | 2,592 | 2,747 |
| Adjustments to net income | 4,617 | 621 | 2,910 |
| Decrease (increase) in accounts receivable | 12,503 | 17,236 | -- |
| Increase (decrease) in liabilities (A/P, taxes payable) | 131,622 | 19,822 | 37,856 |
| Decrease (increase) in inventories | -- | -- | -- |
| Increase (decrease) in other operating activities | (173,057) | (33,061) | (62,963) |
| Net cash flow from operating activities | 13 | 31,799 | (2,404) |
| Investing activities, cash flows provided by or used in: | |||
| Capital expenditures | (4,035) | (3,724) | (3,011) |
| Investments | (201,777) | (71,710) | (75,649) |
| Other cash flows from investing activities | 1,606 | 17,009 | (571) |
| Net cash flows from investing activities | (204,206) | (58,425) | (79,231) |
| Financing activities, cash flows provided by or used in: | |||
| Dividends paid | (9,826) | (9,188) | (8,375) |
| Sale (repurchase) of stock | (5,327) | (12,090) | 133 |
| Increase (decrease) in debt | 101,122 | 26,651 | 21,204 |
| Other cash flows from financing activities | 120,461 | 27,910 | 70,349 |
| Net cash flows from financing activities | 206,430 | 33,283 | 83,311 |
| Effect of exchange rate changes | 645 | (1,840) | 731 |
| Net increase (decrease) in cash and cash equivalents | 2,882 | 4,817 | 2,407 |
See also
- Cash flowCash flowCash flow is the movement of money into or out of a business, project, or financial product. It is usually measured during a specified, finite period of time. Measurement of cash flow can be used for calculating other parameters that give information on a company's value and situation.Cash flow...
- Income statementIncome statementIncome statement is a company's financial statement that indicates how the revenue Income statement (also referred to as profit and loss statement (P&L), statement of financial performance, earnings statement, operating statement or statement of operations) is a company's financial statement that...
- Balance sheetBalance sheetIn financial accounting, a balance sheet or statement of financial position is a summary of the financial balances of a sole proprietorship, a business partnership or a company. Assets, liabilities and ownership equity are listed as of a specific date, such as the end of its financial year. A...
- Statement of retained earningsStatement of retained earningsThe Statement of Retained Earnings are basic financial statements.The statements explain the changes in a company's retained earnings over the reporting...
(statement of changes in equity)