What is a cash flow statement and what is it for? The statement of cash flow, together with the balance sheet (statement of financial position), statement of comprehensive income (income statement), statement of changes in equity, and accompanying explanatory notes to financial statements, are the five components of a complete set of financial statements. Without the statement of cash flows, users of financial statements cannot analyze the changes of cash and cash equivalents reported as current asset in the balance sheet. The following are discussions to give you an idea of what this financial statement is.
What is the statement of cash flow?
The statement of cash flows analyzes changes in cash and cash equivalents during a period (e.g., a statement of cash flows for the year ended December 31, 2010). Cash and cash equivalents comprise cash on hand and demand deposits, together with short-term, highly liquid investments that are readily convertible to a known amount of cash, and that are subject to an insignificant risk of changes in value. The presentation of the statement of cash flows is specified by the International Accounting Standard (IAS) 7.
What are the purpose and uses of the statement of cash flows?
The statement of cash flows is an important component of financial statements because it indicates the liquidity of a certain business or company. Since general financial statements use the accrual method of accounting, the balance sheet and the income statement may give users limited information about a business. Thus, they will refer to the statement of cash flow. The statement of cash flow shows the cash flows from operating activities which is a factor used by users (business owners, investors, creditors, etc.,) to assess the quality of the company’s earnings. When the company’s cash from operating activities is consistently greater than the net income, it indicates that the company’s net income or earning is of a “high quality”. When the cash from operating activities is less than net income, this can raise a question why the reported net income is not turning into cash. The statement of cash flow also tells if a business is generating more cash than it is using. Investors and creditors look into the statement of cash flows of a certain company to identify if it consistently generating a positive cash inflow, which is a good indication that the company will be able to increase dividend, expand its business, and pay off its debts and obligations on time.
How is the statement of cash flow presented?
Cash flows are presented and analyzed into operating, investing and financial activities. Operating activities are the main revenue-producing activities of the business or entity that are not investing or financing activities, such as cash received from customers and cash paid to suppliers and employees. Investing activities are the activities that involve the acquisition and disposal of long-term assets and other investments that are not considered to be cash equivalents, such as property and equipment and investment in equity securities. Financing activities are activities that change the equity capital and borrowing structure of a company or entity. Examples of financing activities are the proceeds and payment of bank loans, and collection from issuance of stocks.
There are two methods that are acceptable in the preparation of a cash flow statement, namely direct method and indirect method. The direct method shows each major class of gross cash receipts and gross cash payments. On the other hand, the indirect method adjusts accrual basis net profit or loss for the effects of non-cash transactions. Other information and explanatory notes to accompany information shown in the face of the statement of cash flows are disclosed in the Notes to Financial Statements.
To see sample audited statements of cash flows of public listed companies in the Philippines, please visit this post.