Understanding Cash Flow Statement-Format and Sections:
Three major financial statements are ordinarily required for external reports―an
income statement, a balance sheet, and a statement of cash flows. The purpose of
the statement of cash flow is to highlight the major activities that directly
and indirectly impact cash flows and hence affect the overall cash balance.
Managers focus on cash for a very good reason―without sufficient cash balance at
the right time, a company may miss golden opportunities or may even fall into
bankruptcy. The cash flow statement answers questions that cannot be
answered by the income statement and a balance sheet. For example a statement of
cash flows can be used to answer questions like where did the company get the cash to pay
dividend of nearly $140 million in a year in which, according to income
statement, it lost more than $1 billion? To answer such questions, familiarity
with the statement of cash flows is required.
The statement of cash flows is a valuable
analytical tool for managers as well as for investors and creditors, although
managers tend to be more concerned with forecasted statements of cash flows that
are prepared as a part of the budgeting process. The statement of cash flows can
be used to answer crucial questions such as the following:
- Is the company generating sufficient positive
cash flows from its ongoing operations to remain viable?
- Will the company be able to repay its debts?
- Will the company be able to pay its usual
- Why is there a difference between net income
and net cash flow for the year?
- To what extent will the company have to
borrow money in order to make needed investments?
For the statement of cash flows to be useful to
managers and others, it is important that companies employ a common definition
of cash. It is also important that a statement be constructed using consistent
guidelines for identifying activities that are sources of cash and uses of cash.
The proper definition of cash and the guidelines to use in identifying sources
are discussed in coming paragraphs.
Definition of Cash:
In preparing a statement of cash flows, the term cash is broadly defined
to include both cash and cash equivalents. Cash equivalents consist of short
term, highly liquid investments such as treasury bills, commercial paper, and
money market funds that are made solely for the purpose of generating a return
on temporary idle funds. Instead of simply holding cash, most companies invest
their excess cash reserves in these types of interest bearing assets that can be
easily converted into cash. These short term liquid investments are usually
included in marketable securities on the balance sheet. Since such assets are
equivalent to cash, they are included with cash in preparing a statement of cash
The cash flow statement is usually divided into three sections:
Operating, investing and financing activities.
Operating activities involve the cash effects of transactions that enter
into the determination of net income, such as cash receipts from sales of
goods and services and cash payments to suppliers and employees for
acquisition of inventory and expenses
Investing activities generally involve long term assets and include
(a) making and collecting loans (b) acquiring and disposing of investments
and productive long lived assets.
Financing activities involve liability and stock holder's equity items and
include obtaining cash from creditors and repaying the amounts borrowed and
obtaining capital from owners and providing them with a return on, and a
return of, their investment. Below is the typical classification of of cash
receipts and payments according to operating, investing and
From sales of goods or services.
From return on loans (interest) and on equity securities. dividends
To suppliers for inventories.
To employees for services.
To government for taxes.
To lenders for interest.
To others for expenses.
Income Statement Items
From sale of property, plant and equipment.
From sale of debt or equity securities of other entities.
From collection of principles on loans to other entities.
To purchase property, plant and equipment.
To purchase debt or equity securities of other entities.
To make loans to other entities.
Generally Long Term Asset Items
Generally Long term Liability and Equity Items
From sale of equity securities.
From issuance of debt ( bonds and notes ).
To stock holders as dividends
To redeem long term debt or reacquire capital stock.
Some cash flow relating to investing or financing activities
are classified as operating activities. For example, receipts of investment
income ( interest and dividend ) and payment of interest to lenders are
classified as operating activities. Conversely, some cash flows relating to
operating activities are classified as investing or financing activities.
For example, the cash received from the sale of property plant and equipment
at a gain, although reported in the income statement, is classified as an
investing activity, and effects of the related gain would not be included in
net cash flow from operating activities. Likewise a gain or loss on the
payment of debt would generally be part of the cash out flow related to the
repayment of the amount borrowed, and therefore it is financing activity.
The three activities discussed in preceding paragraphs constitute the general
format of the statement of cash flows. The cash flows from operating activities
section always appears first, followed by the investing section and then
financing activities section. The individual inflows and outflows from investing
and financing activities are reported separately. That is, they are reported
gross, not netted against one another. Thus, cash outflows from the purchasing of
property is reported separately from the cash inflow the sale of property.
Similarly, the cash inflow from the issuance of debt is reported separately from
the cash outflow from its retirement. The net increase or decrease in cash
reported during the period should reconcile the beginning and ending cash
balances as reported in the comparative balance sheets.
The Skelton cash flow statement
is presented as follows: This is also called cash flow statement pro forma.
Cash Flow Statement Format
Cash Flows From Operating Activities:
Adjustment to reconcile net income to net cash provided by operating
(List of individual items)
Net cash flows from operating activities.
Cash Flows From Investing Activities:
(List of individual inflows and outflows)
Net cash provided (used) by operating activities
Cash Flows from Financing Activities:
(List of individual inflows and outflows)
Net cash provided (used) by financing activities
Net increase (decrease) in cash
Cash at beginning of period
Cash at the end of period