Statement of cash flows

Definition

A statement of cash flows is a financial report that summarizes the inflows and outflows of cash within an organization over a specific period. This statement is crucial as it helps stakeholders understand how well the company generates cash to pay its debts, fund its operating expenses, and support its investment activities.

5 Must Know Facts For Your Next Test

1. The statement of cash flows is divided into three sections: operating activities, investing activities, and financing activities, which helps to categorize how cash is generated and used.
2. This statement provides insight into a company's liquidity and overall financial health, making it easier for investors to evaluate the company's cash position.
3. The indirect method and direct method are two approaches used to prepare the operating section of the statement of cash flows; however, most companies prefer the indirect method due to its simplicity.
4. Cash flow from operations is often seen as a more reliable indicator of a company's performance than net income because it focuses solely on cash transactions.
5. By analyzing trends in the statement of cash flows over multiple periods, stakeholders can assess how well a company manages its cash resources and whether it can sustain operations or expand.

Review Questions

• How does the statement of cash flows help assess a company's ability to generate cash?
  • The statement of cash flows provides a clear view of the actual cash generated and spent by a company during a specific period. By breaking down cash flow into operating, investing, and financing activities, stakeholders can analyze where the cash is coming from and where it's going. This helps assess whether a company has enough liquidity to meet its obligations and invest in future growth.
• Compare and contrast the indirect method and direct method of preparing the operating section of the statement of cash flows.
  • The indirect method starts with net income and adjusts for non-cash transactions, changes in working capital, and other items to arrive at cash flow from operations. In contrast, the direct method lists actual cash receipts and payments from operating activities. While both methods yield the same final cash flow from operations, most companies use the indirect method because it is simpler and provides better insights into the relationship between net income and cash flow.
• Evaluate how trends in the statement of cash flows can impact investment decisions for potential stakeholders.
  • Analyzing trends in the statement of cash flows can significantly influence investment decisions by highlighting a company's financial stability over time. For example, consistent positive cash flow from operations can indicate robust business performance, making it attractive for investors. On the other hand, declining or negative trends may raise red flags about sustainability or operational efficiency. Stakeholders often look for trends that reflect effective cash management practices as they signal potential for future profitability and growth.

Related terms

operating activities: These are the primary revenue-generating activities of a company, including cash received from customers and cash paid to suppliers and employees.

investing activities: These activities relate to the acquisition and disposal of long-term assets and investments, such as purchasing equipment or selling property.

financing activities: These are transactions that result in changes in the size and composition of the equity capital and borrowings of the company, including issuing shares or taking loans.