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The Statement of Cash Flows, or Cash Flow Statement Explained

July 22, 2015 by Ed Becker

The Statement of Cash Flows, or Cash Flow Statement, offers information about the solvency of a company. It presents the movement of cash during the accounting period within the operating, investing and financing categories.

Projections for financial and economic decisions can be formed from information on historic cash flows. Analysis and summaries of key changes during a period can point out priorities to management and other analysts. The information on the statement of cash flows is more objective and does not have the susceptibility of variations possible in the income statement due to differing accounting policies, this allows more accurate analysis.

The preparation of the Cash Flow Statement includes the movement in cash and cash equivalents during the accounting period. Cash and cash equivalents consists of the following:

  • Cash on hand
  • Cash in bank accounts
  • Investments that are short term, and very liquid with a low risk of changes in value.
  • Bank overdrafts that are an integral part of the treasury management

Because the income statement is prepared using accrual basis of accounting the amounts need to be adjusted to present only the movement of cash flow in and out during the period. The cash flows are placed in the following classifications: operating activities, investing activities and financing activities.

Operating Activities

Operating activities cash flow shows the movement of cash from the primary revenue activities of the company during the accounting period. Using profit before taxes as shown in the income statement can be a start point for calculating cash flow from operating activities. There are adjustments that must be made when using profit before tax to get the accurate cash flow from operations.

  • Remove non-cash expenses
  • Remove expenses that are classified somewhere else on the cash flow statement
  • Remove non-cash income-gains on revaluations of investments
  • Remove income that will be classified somewhere else on the cash flow statement
  • Working capital changes-increases in trade receivables needs to be deducted for accurate sales revenue for cash inflow during the accounting period

Investing Activities

Resulting from the purchase and sale of assets that are not part of the company’s primary activity. Cash flow from investment activity is primarily from the following:

  • Expenditures on the purchase of investments and fixed assets
  • Income from investments
  • Cash inflow resulting from disposing of investments or fixed assets

Financing Activities

This classification of cash flow includes:

  • Cash inflow from issuing share capital, debentures and bank loans
  • Expenditures for the cost of finance activities
  • Cash expenditures for the repurchase of share capital and repayment of debentures and bank loans

Examples of the types of things that can be projected from the income statement could show an increase in capital expenses and development expenses, which would lead to expect an increase in future streams of revenue. Or an excessive investment in short term investing would suggest a lack of viable long term opportunities.

The cash flow statement information and analysis is vital for insights about the liquidity and solvency of a company during the accounting period. Also, it allows for analysis of historic cash flows to be compared to current period information to base economic decisions and form projections for future cash flows.

In the next segment of the financial statements series we will have a detailed explanation of the Statement of Changes in Equity.

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