A statement of cash flows, or cash flow statement in financial accounting is a financial statement that illustrates how variations in income and balance sheet accounts affect cash equivalents and cash. The analysis is broken down to investing, operating, and financing activities. In essence, the cash flow statement is primarily concerned with the flow of money both in and out of the business. The statement ports the accompanying changes in the balance sheet as well as the current operating results. As a tool for analysis, the cash flow statement has been proven useful in its ability to determine the short-term liability of a particular company, especially its ability to pay bills.
International Accounting Standard 7 is the international accounting standard that deals specifically with cash flow statements. The list of groups and people who take interest in cash flow statements consist of accounting staff, which job is to be aware of whether the business will be able to cover its expenses, both potential lenders and creditors, who wants solid evidence of a business's capacity to repay loans, potential investors, who need evidence of a company's financial stability, potential employees, who need verification that their salaries will be paid, finally, shareholders of the business.
The cash flow statement was initially referred to as the flow of cash statement. The statement is a depiction of a business's liquidity. The balance sheet is a small illustration of a business's financial stability and liabilities at any given point in time, and the income statement provides a summary of a business's monetary transactions over a period of time. The two financial statements just mentioned are a reflection of the accrual basis of accounting used by businesses to coordinate revenues with their associated expenses. The cash flow statement provides only inflows and outflows of cash equivalents and cash. This means that transactions that have no direct effect on payments and cash receipts are excluded. Among the excluded transactions are depreciation or write-offs on crippling debts or credit loss.
This statement is a cash basis report on three distinct types of financial activities, which are investing activities, operating activities, and financing activities. Activities that do not require cash are generally shown in footnotes, and this occurs both under IAS 7 and US General Accepted Accounting Principles. However, GAAP gives the option of including the non-cash activity within the actual cash flow statement, whereas IAS 7 does not. Included under non-cash financing activities are changing debt to equity, leasing in order to buy an asset, making an exchange of non-cash assets / liabilities for other liabilities or non-cash assets, and bestowing shares as a trade for assets. This statement has four main purposes: to provide insight on a business's solvency and liquidity and its ability to alter cash flows in the future, aid in the evaluation of changes in liabilities, equity, and assets, eliminate effects of differenting accounting methods by standardizing, and provide insight into future cash flows regarding their timing, probability, and amount. The cash flow statement does away with allocations, which could be byproducts of different accounting methods, and therefore has been adopted as a standard financial statement.
Now, the two methods (direct and indirect) of creating these statements will be addressed.
The direct method of preparing a this statement depicts a report which is more clearly understood than the indirect method, which is pretty much universally utilized, due to the fact that FAS 95 states that companies must provide an additional report similar to the indirect method should they choose to utilize the direct method.
The direct method reports major classes of payments and gross cash receipts. Under the rules set forth by IAS 7, received dividends can be shown under either investing or operating activities. If paid taxes are directly connected to operating activities, then that is where they are reported. If paid taxes are directly connected to financial or investing activities, then that is where they are reported. GAAP (Generally Accepted Accounting Principles) are different from IFRS (International Financial Reporting Standards) because under GAAP rules, dividends received through a business's investing activities is actually reported under the operations activities instead of investing activities.
The indirect method makes its starting point net income, adjustments for all non-cash item transactions, then adjustments from every cash based transaction. Away from net income is taken an increase in an asset account, and given to it is an increase in a liability account. This method turns accrual-basis net income / loss into cash flow by utilizing a system of discounts and additions.
The direct method calculates cash flow from operations from scratch, while the indirect method takes net income and makes adjustments in order to calculate cash flow from operations.