The purpose of the cash flow statement is to show owners/investors the amount of money that is flowing in and out of the business over a period of time, typically a year or one quarter.  It also ties together both the income statement and Balance sheet by factoring in various assumptions with money earned by the business and showing the change in assets and liabilities from previous periods.

The cash flow statement is made up of three sections, net cash from operating activities, net cash from investing activities and net cash from financing activities.   Beginning and ending cash are reconciled based on the net effect of all three activities.

Net cash from Operating Activities

Net cash from operating activities takes the items on the income statement and converts them from accrual basis of accounting to cash basis of accounting.  Because the cash generated from operating activities is compared to the company’s net income, if the cash from operating activities is greater than net income this shows investors that the net income of the company is “high quality”.  If cash generated from operating activities is consistently lower than net income it raises the question as to why net income is not turning into cash.  Here is a general format of the operating section of the cash flow statement:

Net Income

      + Depreciation expense

      + Losses

      – Gains

      – Increases in current assets

      + Decreases in current assets

      + Increases in current liabilities

      – Decreases in current liabilities

        ———————————–

      Net Cash from Operating Activities    

Net cash from Investing Activities

Net cash from investing activities shows the purchase and sale of various long-term investments as well as property, plant and equipment.  This section may also include the lending of money and receiving loan payments.  In looking at this section of the cash flow statement one can evaluate whether or not a surplus in operations is being used to grow a company.  On the flip side, a lack in investing activities demonstrates slow or stagnant growth of the company.  Here is a general format of the investing section of the cash flow statement:

+ Proceeds from sale of assets

– Purchases of property and equipment

————————————————————-

Net Cash from Investing Activities

Net cash from Financing Activities

Net cash from financing activities include the borrowing and repaying money, issuing stock (equity) and paying dividends.  This section allows ownwers/investors to determine the amount of cash generated or used as a result of the fore mentioned transactions.  As a company is growing, this section of the cash flow statement will tell owners/ investors the strategies management has used to grow the company.   Here is a general format of the financing section of the cash flow statement:

+ Net Borrowing under line of credit agreement

+ Proceeds from new borrowings

– Repayment of loans

– Principal payments under capital lease obligations

– Dividends/Distributions/Withdrawals Paid

+ Proceeds from issuance of stock

+ Partner/Owner capital contributions

———————————————————————

Net Cash from Financing Activities

Together, all three sections of the cash flow statement show investors the net changes in cash over a period of time.  While the balance sheet and income statement are used for overall management, the cash flow statement gives a better insight into the financial position of the company.  If the cash flow statement is showing an overall positive cash flow, this makes tasks such as acquiring financing a lot easier.  Also, if there is a positive cash flow, owners are able to consider long-term financing to aid in growing the company.

Works Cited:

The Trade Creditor’s Guide to the Statement of Cash Flows, Retrieved January 31, 2013 from http://www.crfonline.org/orc/cro/cro-10.html

Statement of Cash Flows, Retrieved January 31, 2013 from http://ccba.jsu.edu/accounting/STATEMENTCASHFLOWS.HTML