A company’s financial statements consist of three main statements, one of which is the cash flow statement. The cash flow statement shows the movement of cash (and cash equivalents) that the company receives and pays during a certain period.
The objective of the cash flow statement is to provide information about the cash inflows and outflows of a company during a specific period. The cash flow statement is an essential financial statement that helps understand a company’s liquidity, solvency, and financial flexibility. For management, the cash flow statement provides valuable insight into the company’s ability to generate cash from operations, its cash requirements for investments and financing, and how it manages its cash and cash equivalents. It helps management to make informed decisions about resource allocation, investment opportunities, and financing strategies. For stakeholders the cash flow statement is a key indicator of a company’s financial health and sustainability. It helps them assess the company’s ability to generate cash and pay its debts, dividends, and other obligations. The cash flow statement also provides a basis for evaluating the company’s future growth potential and financial performance.
Cash flow mechanics
The cash flow statement reports cash flows during the period classified by operating, investing and financing activities. The total of these cash flows equals the change in the company’s cash balance from the beginning of the period to the reporting date.
1. Operating Activities:
This section shows the cash inflows and outflows arising from the company’s core business operations. It includes items such as cash received from customers, cash paid to suppliers and employees, and interest paid on debt. This section provides important information about the company’s ability to generate cash from its operations, which is a key measure of its financial health.
2. Investing Activities:
This section shows the investing cash inflows and outflows resulting from the company’s investments in long-term assets such as property, plant, and equipment, as well as any purchases or sales of investments or other businesses. This section provides information about the company’s investment activities and can help investors evaluate the company’s long-term growth potential.
3. Financing Activities:
This section shows the cash inflows and outflows resulting from the company’s financing cash flow activities, such as issuing or repurchasing stock, paying dividends, and borrowing or repaying debt. It provides information about the company’s funding activities and can help investors evaluate the company’s financial structure and risk profile.
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Direct vs indirect method
The cash flow statement can be prepared using either the direct or indirect method. The difference between the two methods lies in how the operating activities section of the statement is calculated.
1. Direct method:
The direct method calculates the operating cash flows by directly reporting all cash receipts and cash payments related to the company’s operations during the period. This method requires more detailed information than the indirect method, as it requires a breakdown of each individual item that affects cash flows. The direct method is often preferred by analysts because it provides more detailed information about a company’s operating activities. For example, it would state the amounts received from customers, the amounts paid to suppliers and amounts paid to employees.
2. Indirect method:
The indirect method calculates the operating cash flows by adjusting net income for non-cash transactions and changes in working capital. This method is more commonly used as it is easier and less time-consuming to prepare. It starts with net income, then adjusts for items such as depreciation, changes in accounts receivable and accounts payable and other non-cash items that affect net income. The resulting figure is the net cash flow from operating activities.
Note that cash flows for investing and financing activities must always be presented using the direct method, i.e. stating the amount paid for tangible assets, business combinations, capital received from shareholders or repayments on loans.
The cash flow statement
Given the importance of the cash flow statement, it is essential that the amounts presented are accurate. Ensuring the accuracy of the cash flow statement may involve the following:
The Fidugius solution and your cash flow statement
The Fidugius Accounting & Reporting Manual is a solution that helps companies to improve the reliability of their cash flow statement by providing guidance on how to maintain accurate records through appropriate accounting policies, definition of accounts and accounting treatments. The manual also serves as a training and education resource for new staff members and as a reference for auditors.