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Cash Flows Statement: Six Important Things You Need To Know

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Cash flows statement is an important report that both management and external readers want to have a look to determine the true state of a business entity’s cash flows—which can’t be found within the income statements and balance sheet under the accrual method of accounting. So what is the six important things you need to know about cash flows statement?

This isn’t uncommon that a company may show a great profit on its income statement but has no sufficient cash to pay its debt and dividend.

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By carefully examining the cash flows statement—and comparing it to the income statements and balance sheet, one can get a better view and take a conclusion whether a company is or isn’t really in a great profit—as it may show in its income statements. A cash flows statement reveals the cash inflows and outflows experienced by an organization during a reporting period—monthly, quarterly, semi-annually or annually. The types of cash flows presented are divided into those related to operations, investment activities, and financing activities. Here are six important things you need to know about cash flows statement.

1. Cash Flows Statement in General

The information presented in a cash flows statement is intended to give the reader some idea of the ability of an organization to make debt or dividend payments, or to replace needed capital items—machineries for example.

The same information can also reflect the impact of changes in the management of working capital, since such actions as improved accounts receivable collections or tighter inventory controls will reduce the amount of cash tied up in receivables and inventory (and vice versa.)

A sudden lack of cash has been a fool-proof situation that put fast-growing companies in big financial trouble—where margins from continuing operations may not be sufficient to fund the growth in new sales. A cash flows statement presents a clearer picture of cash flows than can be captured from the income statement or balance sheet—where the use of accruals accounting can make it appear as though an entity is generating large profits.

But a cash flows statement can’t also out—and presented—alone. The statement is an integral part of the financial statements package, alongside the balance sheet, income statement, and statement of retained earnings. This practice has been put in the financial statement reporting standards (FASB and IFRS), since the regulator doesn’t want management of a company try to dress up the cash flows statement—in the need of showing a high level of liquidity—at the expense of a company’s long-term financial health.

For example, management—in purpose—might not be making a sufficient investment in the replacement of existing fixed assets, in the aim to show bigger cash balance, even though this will result in more equipment failures and higher maintenance costs that will eventually appear on the income statement.

2. Three Main Categories of the Cash Flows Statement

A cash flows statement is consisted of three main categories: (a) cash flow from operating activities; (b) cash flow from investing activities; and (c) cash flow from financing activities.

a. Cash Flows From Operating Activities – The first section of the cash flows statement contains cash inflows and outflows that are derived from operating activities, which may be defined as any category of cash flows that does not fall into the investing or financing activities in the next two sections of the report.

Examples of cash inflows in this category are:

  • Receipts of sale transactions
  • Collection of notes receivable
  • Collection of interest income or dividends

Examples of cash outflows in this category are:

  • Payments to suppliers
  • Interest payments
  • Payroll payments
  • Payments for inventory
  • Tax payments

b. Cash Flows From Investing Activities – The second section of cash flows statement contains cash inflows and outflows that are derived from investment activities on the part of the organization issuing the report.

Examples of cash inflows related to investing activities are:

  • Loan principal payments by another entity to the reporting entity
  • Cash received from the sale of fixed assets
  • Sale of another entity’s equity securities by the reporting entity

Examples of cash outflows in this category are:

  • Purchase of assets
  • Loans made to another entity
  • Purchases by the reporting entity of another entity’s equity securities.

c. Cash Flow From Financing Activities – The third section of cash flows statement contains cash inflows and outflows that are derived from financing activities on the part of the organization issuing the report.

Examples of cash inflows related to financing activities are:

  • Proceeds from the issuance of bonds or other types of debt to investors
  • Proceeds from the sale of the reporting entity’s equity securities

Examples of cash outflows in this category are:

  • Debt repayments
  • Cash paid for debt issuance costs
  • Dividend payments to the holders of the reporting entity’s equity securities
  • Repurchase of the reporting entity’s equity securities

3. Format Of Cash Flows Statement

Three main categories of the cash flows statement is presented in, usually, a page of report presentation. There is no one uniform format, for all companies that the accountant must follow for presentation purposes.

The most important aspect that should be met by a cash flows statement report is that it must be separated into the operating, investing, and financing activities, but the level of detailed reporting within those categories is up to the accountant’s judgment. It contains enough information for the reader to understand where cash flows are occurring, and how they vary from the reported net income.

As shown on below cash flows statement example, the bottom of the report includes a reconciliation that adjusts the net income figure to the net amount of cash provided by operating activities (see the blue array on the example)—this is useful for showing the impact of non-cash items, such as depreciation, amortization, and accruals, on the amount of cash provided from operating activities. The reconciliation snippet is a further detail of the cash flows from the operating activities.

Format of Cash Flows Statement

4. Cash Flows Statement Exemptions

There is exemption. An investment company IS NOT required to present a statement of cash flows, as long as it falls within the following parameters:

  • It has minimal debt.
  • It issues a statement of changes in net assets.
  • Its investments are carried at market value.
  • Nearly all of its investments are highly liquid.

Defined benefit plans and certain other types of employee benefit plans are also not required to issue a statement of cash flows, as long as they follow the guidelines of the accounting standard (FASB Statement Number 35 for U.S. companies).

5. Treatment Of Foreign Currency Transactions On Cash Flow Statement

When a company is located in a foreign location, or has a subsidiary located in there, a separate statement of cash flows should be created for the foreign entity. This statement is then translated into the reporting currency for the parent company, using the exchange rate that was current at the time when the cash flows occurred.

If the cash flows were spread equably over the entire reporting period, then the exchange rate used can be a weighted average, so long as the final reporting result is essentially the same. The resulting cash flows statement for the foreign entity may then be consolidated into the statement of cash flows for the entire organization.

6. Cash Flow Statement’s Presentation in Consolidated Entities

When constructing the cash flows statement as part of a consolidated set of financial statements, all other statements must first be consolidated (this is necessary because information is pulled from the other statements in order to complete the statement of cash flows.) Then complete the following consolidation steps:

Step-1. Eliminate all non-cash transactions related to the business combination.

Step-2. Eliminate all inter-company operating transactions, such as sales of products between divisions.

Step-3. Eliminate all inter-company investing transactions, such as the purchase of equity securities by different divisions.

Step-4. Eliminate all inter-company financing activities, such as dividend payments between divisions.

Step-5. Add back any income or loss that has been allocated to non-controlling parties, since this is not an actual cash flow.

1 Comment

1 Comment

  1. Jeff M

    Oct 7, 2012 at 4:18 am

    Could you please send me the Cashflow Spreadsheet. I think it is excellent. Thanks.

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