The cash flow statement (or statement of cash flows) is one of the main financial statements. The cash flow statement explains how a company's cash and cash equivalents have changed during a specified period of time.
The cash flow statement is organized into three sections:
1. Cash provided and used by operating activities,
2. Cash provided and used by investing activities,
3. Cash provided and used by financing activities.
A positive amount indicates the item had a positive effect on the company's cash balance. A negative amount indicates that the item had a negative effect on the company's cash balance.
Under the indirect method of preparing and presenting the cash flow statement, the operating activities section begins with the net income during the period of the statement. Since the company's net income was calculated and reported using the accrual basis of accounting, the amount of net income needs to be adjusted to a cash amount. The first adjustment is to add back the amount of depreciation, depletion, and amortization expenses, since these expenses had reduced net income but did not reduce the company's cash. Next, any gains or losses on the sale of long-term assets used in the business are listed, since the entire amount received from the sale of assets is reported under investing activities. Lastly, the changes in the current assets (other than cash) and the changes in current liabilities are listed. For example, if inventory has increased, the amount of the increase in inventory is subtracted because additional cash would have been used to increase the amount of inventory. The amount by which a current liability decreased is also subtracted, since it is assumed that cash was used to decrease the current liability. All of the items reported in the operating activities section are combined into a final number: the net amount of cash provided by operating activities.
The second section of the cash flow statement reports a company's investing activities. The changes in the long-term asset account balances are reported in this section. For example, if a company's long-term investment in another company has increased during the period, the amount of the increase is reported as a negative amount in the investing activities section—an indication that cash was used. The same is true for the purchase of property, plant and equipment for use in the business—an increase in the equipment account indicates that cash was used to purchase equipment. If a long-term investment or plant asset is sold, the entire amount received from the sale is reported as a positive amount in the investing activities section. This indicates that cash was provided or increased from the sale. (Any gain or loss on the sale is an adjustment to the net income reported in the operating activities section of the statement.)
The third section of the cash flow statement reports a company's financing activities. This section lists the changes in long-term liabilities and stockholders' equity. For example, if Bonds Payable has increased by $1,000,000, it is assumed that cash of $1,000,000 was provided. The $1,000,000 will appear as a positive amount in the financing activities section of the statement. If Bonds Payable decreased, then the amount of the decrease will be reported as a negative amount—indicating that cash was used to retire the bonds. The amount of dividends declared and paid will also appear as a negative amount, since cash was used. If the company sells some of its shares of stock, the amount received will be reported as a positive amount since it provided cash. If the company purchases some of its shares of stock, the amount will appear as a negative amount in the financing activities section because the company's cash was used.
In addition to the three main sections of the cash flow statement, it is also necessary to disclose significant noncash transactions (e.g. exchanging shares of stock for land) and other items required by generally accepted accounting principles.
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Harold Averkamp (CPA, MBA) has worked as a university accounting instructor, accountant, and consultant for more than 25 years. He is the sole author of all the materials on AccountingCoach.com. Read more about the author.