There are four main financial statements.

They are: (1) balance sheets; (2) income

statements; (3) cash flow statements; and (4) statements of shareholders' equity.
Balance sheets show what a company owns and what it owes at a fixed point in
time.

Cash Flow Statements

Cash flow statements report a companys inflows and outflows of cash. This is important because a
company needs to have enough cash on hand to pay its expenses and purchase assets. While an income
statement can tell you whether a company made a profit, a cash flow statement can tell you whether the
company generated cash.
A cash flow statement shows changes over time rather than absolute dollar amounts at a point in time. It
uses and reorders the information from a companys balance sheet and income statement.
The bottom line of the cash flow statement shows the net increase or decrease in cash for the period.
Generally, cash flow statements are divided into three main parts. Each part reviews the cash flow from
one of three types of activities: (1) operating activities; (2) investing activities; and (3) financing activities.

Operating Activities

The first part of a cash flow statement analyzes a companys cash flow from net income or losses. For
most companies, this section of the cash flow statement reconciles the net income (as shown on the
income statement) to the actual cash the company received from or used in its operating activities. To do
this, it adjusts net income for any non-cash items (such as adding back depreciation expenses) and
adjusts for any cash that was used or provided by other operating assets and liabilities.

Investing Activities
The second part of a cash flow statement shows the cash flow from all investing activities, which generally
include purchases or sales of long-term assets, such as property, plant and equipment, as well as
investment securities. If a company buys a piece of machinery, the cash flow statement would reflect this
activity as a cash outflow from investing activities because it used cash. If the company decided to sell off
some investments from an investment portfolio, the proceeds from the sales would show up as a cash
inflow from investing activities because it provided cash.

Financing Activities
The third part of a cash flow statement shows the cash flow from all financing activities. Typical sources of
cash flow include cash raised by selling stocks and bonds or borrowing from banks. Likewise, paying back
a bank loan would show up as a use of cash flow.

Statement of Cash Flows Overview

The statement of cash flows is part of the financial statements issued by a business, and describes the
cash flows into and out of the organization. Its particular focus is on the types of activities that create
and use cash, which are operations, investments, and financing. Though the statement of cash flows is
generally considered less critical than the income statement and balance sheet, it can be used to
discern trends in business performance that are not readily apparent in the rest of the financial
statements. It is especially useful when there is a divergence between the amount of profits reported
and the amount of net cash flow generated by operations.
There can be significant differences between the results shown in the income statement and the cash
flows in this statement, for the following reasons:

There are timing differences between the recordation of a transaction and when the related
cash is actually expended or received.

Management may be using aggressive revenue recognition to report revenue for which cash
receipts are still some time in the future.

The business may be asset intensive, and so requires large capital investments that do not
appear in the income statement, except on a delayed basis as depreciation.
Many investors feel that the statement of cash flows is the most transparent of the financial
statements (i.e., most difficult to fudge), and so they tend to rely upon it more than the other financial
statements to discern the true performance of a business.
Cash flows in the statement are divided into the following three areas:

Operating activities. These constitute the revenue-generating activities of a business.

Examples of operating activities are cash received and disbursed for product sales, royalties,
commissions, fines, lawsuits, supplier and lender invoices, and payroll.

Investing activities. These constitute payments made to acquire long-term assets, as well as
cash received from their sale. Examples of investing activities are the purchase of fixed assets and the
purchase or sale of securities issued by other entities.

Financing activities. These constitute activities that will alter the equity or borrowings of a
business. Examples are the sale of company shares, the repurchase of shares, and dividend
payments.
There are two ways in which to present the statement of cash flows, which are the direct method and
the indirect method. The direct method requires you to present cash flow information that is directly
associated with the items triggering cash flows, such as:

Cash collected from customers

Interest and dividends received

Cash paid to employees

Cash paid to suppliers

Interest paid

Income taxes paid

Few organization collect information as required for the direct method, so they instead use the indirect
method. Under the indirect approach, the statement begins with the net income or loss reported on
the company's income statement, and then makes a series of adjustments to this figure to arrive at
the amount of net cash provided by operating activities. The following links provide more information
about the direct method and indirect method.

Direct method

Indirect method

Cash Flow Statement Direct Method

The direct method of presenting the statement of cash flows presents the specific cash flows
associated with items that affect cash flow. Items that typically do so include:

Cash collected from customers

Interest and dividends received

Cash paid to employees

Cash paid to suppliers

Interest paid

Income taxes paid

The advantage of the direct method over the indirect method is that it reveals operating cash receipts
and payments.
The standard-setting bodies encourage the use of the direct method, but it is rarely used, for the
excellent reason that the information in it is difficult to assemble; companies simply do not collect and
store information in the manner required for this format. Using the direct method may require that the
chart of accounts be restructured in order to collect different types of information. Instead, they use
the indirect method, which can be more easily derived from existing accounting reports.
Statement of Cash Flows Direct Method Example
Lowry Locomotion constructs the following statement of cash flows using the direct method:
Lowry Locomotion
Statement of Cash Flows
for the year ended 12/31/x1
Cash flows from operating activities
Cash receipts from customers
Cash paid to suppliers
Cash paid to employees
Cash generated from operations
Interest paid
Income taxes paid
Net cash from operating activities

$45,800,000
(29,800,000)
(11,200,000)
4,800,000
(310,000)
(1,700,000)

Cash flows from investing activities

Purchase of property, plant, and equipment
Proceeds from sale of equipment
Net cash used in investing activities

(580,000)
110,000

Cash flows from financing activities

Proceeds from issuance of common stock
Proceeds from issuance of long-term debt
Principal payments under capital lease obligation
Dividends paid
Net cash used in financing activities

1,000,000
500,000
(10,000)
(450,000)

$2,790,000

(470,000)

1,040,000

Net increase in cash and cash equivalents

Cash and cash equivalents at beginning of period
Cash and cash equivalents at end of period

3,360,000
1,640,000
$5,000,000

Reconciliation of net income to net cash provided by operating activities:

Net income
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization
$125,000
Provision for losses on accounts receivable
15,000
Gain on sale of equipment
(155,000)
Increase in interest and income taxes payable
32,000
Increase in deferred taxes
90,000
Increase in other liabilities
18,000
Total adjustments
Net cash provided by operating activities

$2,665,000

125,000
$2,790,000

Cash Flow Statement Indirect Method

The statement of cash flows is one of the components of a company's set of financial statements, and
is used to reveal the sources and uses of cash by a business. It presents information about cash
generated from operations and the effects of various changes in the balance sheet on a company's
cash position.
Under the indirect method of presenting the statement of cash flows, the presentation of this
statement begins with net income or loss, with subsequent additions to or deductions from that
amount for non-cash revenue and expense items, resulting in net income provided by operating
activities.
The format of the indirect method appears in the following example. In the presentation format, cash
flows are divided into the following general classifications:

Cash flows from operating activities

Cash flows from investing activities

Cash flows from financing activities

The indirect method of presentation is very popular, because the information required for it is
relatively easily assembled from the accounts that a business normally maintains in its chart of
accounts. The indirect method is less favored by the standard-setting bodies, since it does not give a
clear view of how cash flows through a business (as is shown under the direct method of
presentation).
Statement of Cash Flows Indirect Method Example
For example, Lowry Locomotion constructs the following statement of cash flows using the indirect
method:
Lowry Locomotion
Statement of Cash Flows
for the year ended 12/31x1
Cash flows from operating activities
Net income

$3,000,000

Adjustments for:
Depreciation and amortization
Provision for losses on accounts receivable
Gain on sale of facility

$125,000
20,000
(65,000)

Increase in trade receivables

Decrease in inventories
Decrease in trade payables

(250,000)
325,000
(50,000)

80,000

25,000
3,105,000

Cash generated from operations

Cash flows from investing activities
Purchase of property, plant, and equipment
Proceeds from sale of equipment
Net cash used in investing activities
Cash flows from financing activities
Proceeds from issue of common stock
Proceeds from issuance of long-term debt
Dividends paid
Net cash used in financing activities

(500,000)
35,000
(465,000)
150,000
175,000
(45,000)
280,000

Net increase in cash and cash equivalents

Cash and cash equivalents at beginning of period
Cash and cash equivalents at end of period

2,920,000
2,080,000
$5,000,000

How to prepare a cash flow statement

A statement of cash flows contains information about the flows of cash into and out of a company, and
the uses to which the cash is put. The statement is comprised of three sections, in which are
presented the cash flows that occurred during the reporting period relating to the following:

Operations

Investing activities

Financing activities
The statement of cash flows is part of the financial statements, and as such is heavily reviewed by the
users of the financial statements.
The most commonly used format for the statement of cash flows is called the indirect method. The
general layout of an indirect method statement of cash flows is shown below, along with an
explanation of the source of the information in the statement. The sources of information appearing in
the table can be used to prepare a cash flow statement.
ABC Company
Statement of Cash Flows (indirect method)
for the year ended 12/31/20X1

Line Item
Cash flows from operating
activities
Net income
Adjustments for:
Depreciation and amortization

Derivation
From the net income line on the income statement
From the corresponding line items in the income statement

Provision for losses on accounts

receivable
Gain/loss on sale of facility
Increase/decrease in trade
receivables

From the change in the allowance for doubtful accounts in the

period
From the gain/loss accounts in the income statement
Change in trade receivables during the period, from the
balance sheet
Change in inventories during the period, from the balance
Increase/decrease in inventories
sheet
Increase/decrease in trade
Change in trade payables during the period, from the balance
payables
sheet
Cash generated from operations Summary of the preceding items in this section
Cash flows from investing
activities
Purchase of fixed assets
Itemized in the fixed asset accounts during the period
Proceeds from sale of fixed assets Itemized in the fixed asset accounts during the period
Net cash used in investing
Summary of the preceding items in this section
activities
Cash flows from financing
activities
Proceeds from issuance of
common stock
Proceeds from issuance of longterm debt
Dividends paid
Net cash used in financing
activities
Net change in cash and cash
equivalents

Net increase in the common stock and additional paid-in

capital accounts during the period
Itemized in the long-term debt account during the period
Itemized in the retained earnings account during the period
Summary of the preceding items in this section
Summary of all preceding subtotals

A less commonly-used format for the statement of cash flows is the direct method. The general layout
of the direct method statement of cash flows is shown below, along with an explanation of the source
of the information in the statement. This information can be used to prepare a cash flow statement.
ABC Company
Statement of Cash Flows (direct method)
for the year ended 12/31/20X1

Line Item
Derivation
Cash flows from operating
activities
Cash receipts from customers Summary of the cash receipts journal for the period
Summary of the cash disbursements journal for the period (less
Cash paid to suppliers
the financing payments noted below)
Cash paid to employees
Summary of the payroll journal for the period
Cash generated from
Summary of the preceding items in this section
operations

Interest paid
Income taxes paid
Net cash from operating
activities
Cash flows from investing
activities
Purchase of fixed assets
Proceeds from sale of fixed
assets
Net cash used in investing
activities
Cash flows from financing
activities
Proceeds from issuance of
common stock
Proceeds from issuance of
long-term debt
Principal payment under
capital leases
Dividends paid
Net cash used in financing
activities

Itemized in the cash disbursements journal

Itemized in the cash disbursements journal
Summary of the preceding items in this section

Itemized in the fixed asset accounts during the period

Itemized in the fixed asset accounts during the period
Summary of the preceding items in this section

Net increase in the common stock and additional paid-in capital

accounts during the period
Itemized in the long-term debt account during the period
Itemized in the capital leases liability account during the period
Itemized in the retained earnings account during the period
Summary of the preceding items in this section

Net change in cash and cash

Summary of all preceding subtotals
equivalents