Cash Flow Statement

A cash flow statement is a financial report that describes the source of a company's cash and how
it was spent over a specified time period. Because of the varied accrual accounting methods
companies may employ, it is possible for a company to show profits while not having enough
cash to sustain operations.
A cash flow statement neutralizes the impact of the accrual entries on the other financial
statements. It also categorizes the sources and uses of cash to provide the reader with an
understanding of the amount of cash a company generates and uses in its operations, as opposed
to the amount of cash provided by sources outside the company, such as borrowed funds or funds
from stockholders.
The cash flow statement also tells the reader how much money was spent for items that do not
appear on the income statement, such as loan repayments, long-term asset purchases, and
payment of cash dividends.
Cash flow statements classify cash receipts and payments according to whether they stem from
operating, investing, or financing activities.
It also provides that the statement of cash flows may be prepared under either the direct or
indirect method, and provides illustrative examples for the preparation of statements of cash
flows under both the direct and the indirect methods.
CLASSIFICATIONS OF CASH RECEIPTS AND PAYMENTS- At the beginning of a
company's life cycle, a person or group of people come up with a idea for a new company. The
initial money comes from the owners, or could be borrowed. This is how the new company is
"financed." The money owners put into the company, or money the company borrows, is
classified as a financing activity. Generally, any item that would be classified on the balance
sheet as either a long-term liability or an equity would be a candidate for classification as a
financing activity.
The owners or managers of the business use the initial funds to buy equipment or other assets
they need to run the business. In other words, they invest it. The purchase of property, plant,
equipment, and other productive assets is classified as an investing activity. Sometimes a
company has enough cash of its own that it can lend money to another enterprise. This, too,
would be classified as an investing activity. Generally, any item that would be classified on the
balance sheet as a long-term asset would be a candidate for classification as an investing activity.

Now the company can start doing business. It has procured the funds and purchased the
equipment and other assets it needs to operate. It starts to sell merchandise or services and make
payments for rent, supplies, taxes, and all of the other costs of doing business. All of the cash
inflows and outflows associated with doing the work for which the company was established
would be classified as an operating activity. In general, if an activity appears on the company's
income statement, it is a candidate for the operating section of the cash flow statement.

ACCRUAL AND ITS EFFECT ON FINANCIAL STATEMENTS Generally accepted

accounting principles (GAAP) require that financial statements are prepared on the accrual basis.
For example, revenues that were earned during an accounting period may not have been
collected during that period, and appear on the balance sheet as accounts receivable. Similarly,
some of the collections of that period may have been from sales made in prior periods. Cash may
have been collected in a period prior to the services rendered or goods delivered, resulting in
deferred recognition of the revenue. This would appear on the balance sheet as unearned
revenue.
Sometimes goods or services are paid for prior to the period in which the benefit is matched to
revenue (recognized). This results in a deferred expense, or a prepaid expense. Items such as
insurance premiums that are paid in advance of the coverage period are classified as prepaid.
Sometimes goods or services are received and used by the company before they are paid for,
such as telephone service or merchandise inventory. These items are called accrued expenses, or
payables, and are recognized on the income statement as an expense before the cash flow occurs.
When buildings or equipment are purchased for cash, the cash flow precedes the recognition of
the expense by many years. The expense is recognized over the life of the asset as depreciation.
One of the main benefits of the cash flow statement is that it removes the effect of any such
accruals or deferrals.
METHODS OF PREPARING THE CASH FLOW STATEMENT. Small business owners
preparing a cash flow statement chan choose either the direct or the indirect method of cash flow
statement presentation. The operating section of a cash flow statement prepared using either
method converts the income statement from the accrual to the cash basis, and reclassifies any
activity not directly associated with the basic business activity of the firm. The difference lies in
the presentation of the information.
Companies that use the direct method are required, at a minimum, to report separately the
following classes of operating cash receipts and payments:

RECEIPTS. Companies are encouraged to provide further breakdown of operating cash receipts
and payments that they consider meaningful.
Companies using either method to prepare the cash flow statement are also required to separately
disclose changes in inventory, receivables, and payables to reconcile net income (the result of the
income statement) to net cash flow from operating activities. In addition, interest paid (net of
amount capitalized) and income taxes paid must be disclosed elsewhere in the financial
statements or accompanying notes. An acceptable alternative presentation of the indirect method
is to report net cash flow from operating activities as a single line item in the statement of cash
flows and to present the reconciliation details elsewhere in the financial statements.
The reconciliation of the operating section of a cash flow statement using the indirect method
always begins with net income or loss, and is followed by an "adjustments" section to reconcile
net income to net cash provided by operating activities.
Regardless of whether the direct or the indirect method is used, the operating section of the cash
flow statement ends with net cash provided (used) by operating activities. This is the most
important line item on the cash flow statement. A company has to generate enough cash from
operations to sustain its business activity. If a company continually needs to borrow or obtain
additional investor capitalization to survive, the company's long-term existence is in jeopardy.
The presentation of the investing and financing sections is the same regardless of whether the
statement is prepared using the direct or indirect method. The final section of the cash flow
statement is always a reconciliation of the net increase or decrease in cash for the period for
which the statement is prepared, with the beginning and ending balances in cash for the period.
Analyzing and Classifying Common Transactions
Transactions on the balance sheet also must be analyzed and converted from the accrual to the
cash basis in preparation of the cash flow statement. Every balance sheet account reflects
specific activity. There are only a few distinctive transactions that affect each account. Following
are examples of some of the common transactions affecting balance sheet items:
Accounts receivable increases when the company sells merchandise or does a service on credit,
and decreases when the customer pays its bill. Accounts receivable is associated with the income
statement account Sales or Revenue. The change in accounts receivable or the cash collected
from customers is classified as an operating activity.
Inventory increases when the company buys merchandise for resale or use in its manufacturing
process, and decreases when the merchandise is sold. Inventory is associated with the income

statement account Cost of Goods Sold. The change in inventory or the cash paid for inventory
purchases is classified as an operating activity.

Prepaid insurance increases when the company pays insurance premiums covering future periods
and decreases when the time period of coverage expires. Prepaid insurance is associated with the
income statement account Insurance Expense. The change in prepaids or the amount paid for
insurance is classified as an operating activity.
The Land, Building, and Equipment accounts increase when the company purchases additional
assets. They also undergo a corresponding decrease when the assets are sold. The only time the
income statement is affected is when the asset is sold at a price higher or lower than book value,
at which time a gain or loss on sale of assets appears on the income statement. The amount of
cash used or received from the purchase or sale of such assets is classified as an investing
activity. The gain or loss is classified as an adjustment in the operating section on a cash flow
statement prepared using the indirect method.
Accumulated depreciation increases as the building and equipment depreciates and decreases
when building and equipment is sold. Accumulated depreciation is associated with depreciation
expense on the income statement. Depreciation expense does not appear on a cash flow
statement presented using the direct method. Depreciation expense is added back to net income
on a cash flow statement presented using the indirect method, since the depreciation caused net
income to decrease during the period but did not affect cash.
Goodwill increases when the parent company acquires a subsidiary for more than the fair market
value of its net assets. Goodwill amortizes over a time period not to exceed 40 years. Goodwill is
associated with amortization expense on the income statement. Amortization expense appears in
the operating section of a cash flow statement prepared using the indirect method. Amortization
expense does not appear on a cash flow statement prepared using the direct method.
Notes payable increases when the company borrows money, and decreases when the company
repays the funds borrowed. Since only the principal appears on the balance sheet, there is no
impact on the income statement for repaying the principal component of the note. Notes payable
appear in the financing section of a cash flow section.
Premiums and discounts on bonds are amortized through bond interest expense. There is no cash
flow associated with the amortization of bond discounts or premiums. Therefore, there will
always be an adjustment in the operating section of the cash flow statement prepared using the
indirect method for premium or discount amortization. Premium or discount amortization will
not appear on a cash flow statement prepared using the direct method.
Common stock and preferred stock with their associated paid in capital accounts increase when
additional stock is sold to investors, and decrease when stock is retired. There is no income

statement impact for stock transactions. The cash flow associated with stock sales and
repurchases appears in the financing section.

Retained earnings increases when the company earns profits and decreases when the company
suffers a loss or declares dividends. The profit or loss appears as the first line of the operating
section of the cash flow statement. The dividends appear in the financing section when they are
paid.
CASH INFLOWS OR RECEIPTS. When preparing the cash flow statement using the direct
method, the cash collected from customers may be found by analyzing accounts receivable, as
follows: Beginning balance of accounts receivable, plus sales for the period (from the income
statement), less ending balance of accounts receivable, equals cash received from customers.
This is an extremely simplified formula, and does not take into account written off receivables or
other noncash adjustments to customer accounts. If there is no accounts receivable on the
balance sheet, the company does a cash business and cash collected from customers will equal
sales or revenue on the income statement.
If the cash flow statement is prepared using the indirect method, the adjustment to net income
may be found in a similar manner. If the cash received from customers is more than the sales
shown on the income statement, causing accounts receivable to decrease, the difference is added
to net income. If cash received from customers is less than the sales shown on the income
statement, causing accounts receivable to increase, the difference is subtracted from net income.
The amounts borrowed during the period may be found by analyzing the Liability Accounts. The
amounts received from investors during the period may be found by doing a similar analysis on
the Equity Accounts. Both of these types of transactions will be classified as financing activities.
If any land, buildings, or equipment were sold during the period, the information will be found in
the Land, Building, and Equipment Accounts and their associated accumulated depreciation. One
simple way to properly categorize the transaction is to reconstruct the journal entry. For example,
assume that equipment that had cost $8,000 and had accumulated depreciation of $6,000 was
sold during the period for $2,500. The journal entry for this transaction should indicate:

The cash received from the sale of the equipment is classified as an investing activity. If the
statement is prepared using the direct method, no other part of the journal entry is used. If the
statement is prepared using the indirect method, the gain on sale of equipment is subtracted from
net income. When the gain was recorded, net income increased. However, since the company is
not in the business of buying and selling equipment, the gain needs to be subtracted from net
income to arrive at the adjusted total related only to the proceeds from the company's direct
business activities. If the sale had resulted in a loss, the loss is added back to net income.
CASH PAYMENTS. Cash payments are found using similar methods to those used for
determining cash received. Cash payments for the purchase of inventory are found by analyzing
accounts payable. The following formula can be used to find the cash paid for inventory
purchases: beginning balance of accounts payable, plus inventory purchases during the period,
less ending balance of accounts payable, equals payments made for inventory during the period.
This is a simplified formula and does not take into account any noncash adjustments.
If the cash paid for inventory is greater than the inventory purchased during the period, the
difference between the amount purchased and the amount paid is deducted from net income if
preparing the cash flow statement using the indirect method. If cash paid for inventory is less
than the inventory purchased during the period, the difference between the amount purchased
and the amount paid is added to net income if preparing the cash flow statement using the
indirect method. Cash payments for land, building, and equipment purchases, repayments of
loans, purchases of treasury stock, and payment of dividends may be found by performing
similar analysis on the appropriate accounts.
SIGNIFICANT NONCASH TRANSACTIONS. Noncash transactions are not to be
incorporated in the statement of cash flows. Examples of these types of transactions include
conversion of bonds to stock and the acquisition of assets by assuming liabilities. If there are
only a few such transactions, it may be convenient to include them on the same page as the
statement of cash flows, in a separate schedule at the bottom of the statement. Otherwise, the
transactions may be reported elsewhere in the financial statements, clearly referenced to the
statement of cash flows.
Other events that are generally not reported in conjunction with the statement of cash flows
include stock dividends, stock splits, and appropriation of retained earnings. These items are
generally reported in conjunction with the statement of retained earnings or schedules and notes
pertaining to changes in capital accounts.

In financial accounting, a cash flow statement, also known as statement of cash flows or funds
flow statement,[1] is a financial statement that shows how changes in balance sheet accounts and
income affect cash and cash equivalents, and breaks the analysis down to operating, investing,
and financing activities. Essentially, the cash flow statement is concerned with the flow of cash
in and cash out of the business. The statement captures both the current operating results and the
accompanying changes in the balance sheet.[1] As an analytical tool, the statement of cash flows
is useful in determining the short-term viability of a company, particularly its ability to pay bills.
International Accounting Standard 7 (IAS 7), is the International Accounting Standard that deals
with cash flow statements.
People and groups interested in cash flow statements include:

Accounting personnel, who need to know whether the organization will be able to cover
payroll and other immediate expenses

Potential lenders or creditors, who want a clear picture of a company's ability to repay

Potential investors, who need to judge whether the company is financially sound

Potential employees or contractors, who need to know whether the company will be able
to afford compensation

Shareholders of the business.

The cash flow statement was previously known as the flow of funds statement.[2] The cash flow
statement reflects a firm's liquidity.
The balance sheet is a snapshot of a firm's financial resources and obligations at a single point in
time, and the income statement summarizes a firm's financial transactions over an interval of
time. These two financial statements reflect the accrual basis accounting used by firms to match
revenues with the expenses associated with generating those revenues. The cash flow statement
includes only inflows and outflows of cash and cash equivalents; it excludes transactions that do
not directly affect cash receipts and payments. These noncash transactions include depreciation
or write-offs on bad debts or credit losses to name a few.[3] The cash flow statement is a cash
basis report on three types of financial activities: operating activities, investing activities, and
financing activities. Noncash activities are usually reported in footnotes.
The cash flow statement is intended to[4]

1. provide information on a firm's liquidity and solvency and its ability to change cash flows
in future circumstances
2. provide additional information for evaluating changes in assets, liabilities and equity
3. improve the comparability of different firms' operating performance by eliminating the
effects of different accounting methods
4. indicate the amount, timing and probability of future cash flows
The cash flow statement has been adopted as a standard financial statement because it eliminates
allocations, which might be derived from different accounting methods, such as various
timeframes for depreciating fixed assets.[5]

Cash flow activities

The cash flow statement is partitioned into three segments, namely: cash flow resulting from
operating activities, cash flow resulting from investing activities, and cash flow resulting from
financing activities.
The money coming into the business is called cash inflow, and money going out from the
business is called cash outflow.

Operating activities
Operating activities include the production, sales and delivery of the company's product as well
as collecting payment from its customers. This could include purchasing raw materials, building
inventory, advertising, and shipping the product.
Under IAS 7, operating cash flows include:[13]

Receipts from the sale of goods or services

Receipts for the sale of loans, debt or equity instruments in a trading portfolio

Interest received on loans

Dividends received on equity securities

Payments to suppliers for goods and services

Payments to employees or on behalf of employees

Interest payments (alternatively, this can be reported under financing activities in IAS 7,
and US GAAP)

Items which are added back to [or subtracted from, as appropriate] the net income figure (which
is found on the Income Statement) to arrive at cash flows from operations generally include:

Depreciation (loss of tangible asset value over time)

Deferred tax

Amortization (loss of intangible asset value over time)

Any gains or losses associated with the sale of a non-current asset, because associated
cash flows do not belong in the operating section.(unrealized gains/losses are also added
back from the income statement)

Investing activities
Examples of Investing activities are

Purchase of an asset (assets can be land, building, equipment, marketable securities, etc.)

Loans made to suppliers or customers

Financing activities
Financing activities include the inflow of cash from investors such as banks and shareholders, as
well as the outflow of cash to shareholders as dividends as the company generates income. Other
activities which impact the long-term liabilities and equity of the company are also listed in the
financing activities section of the cash flow statement.
Under IAS 7,

Proceeds from issuing short-term or long-term debt

Payments of dividends

Payments for repurchase of company shares

Repayment of debt principal, including capital leases

For non-profit organizations, receipts of donor-restricted cash that is limited to long-term

purposes

Items under the financing activities section include:

Dividends paid

Sale or repurchase of the company's stock

Net borrowings

Payment of dividend tax

Disclosure of noncash activities

Under IAS 7, noncash investing and financing activities are disclosed in footnotes to the
financial statements. Under US GAAP, noncash activities may be disclosed in a footnote or
within the cash flow statement itself. Noncash financing activities may include[14]

Leasing to purchase an asset

Converting debt to equity

Exchanging noncash assets or liabilities for other noncash assets or liabilities

Issuing shares in exchange for assets

Preparation methods
The direct method of preparing a cash flow statement results in a more easily understood report.
[15]
The indirect method is almost universally used, because FAS 95 requires a supplementary
report similar to the indirect method if a company chooses to use the direct method.

Direct method

The direct method for creating a cash flow statement reports major classes of gross cash receipts
and payments. Under IAS 7, dividends received may be reported under operating activities or
under investing activities. If taxes paid are directly linked to operating activities, they are
reported under operating activities; if the taxes are directly linked to investing activities or
financing activities, they are reported under investing or financing activities.
Sample cash flow statement using the direct method[16]
Cash flows from (used in) operating activities
Cash receipts from customers
Cash paid to suppliers and employees
Cash generated from operations (sum)
Interest paid
Income taxes paid
Net cash flows from operating activities
Cash flows from (used in) investing activities
Proceeds from the sale of equipment
Dividends received
Net cash flows from investing activities
Cash flows from (used in) financing activities
Dividends paid
Net cash flows used in financing activities
.
Net increase in cash and cash equivalents
Cash and cash equivalents, beginning of year
Cash and cash equivalents, end of year

27,500
(20,000)
7,500
(2,000)
(4,000)
1,500
7,500
3,000
10,500
(2,500)
(2,500)
9,500
1,000
$10,500

Indirect method
The indirect method uses net-income as a starting point, makes adjustments for all transactions
for non-cash items, then adjusts for all cash-based transactions. An increase in an asset account is
subtracted from net income, and an increase in a liability account is added back to net income.
This method converts accrual-basis net income (or loss) into cash flow by using a series of
additions and deductions.[17]
Rules

The following rules are used to make adjustments for changes in current assets and liabilities,
operating items not providing or using cash and nonoperating items.[18]

Decrease in non-cash current assets are added to net income

Increase in non-cash current asset are subtracted from net income

Increase in current liabilities are added to net income

Decrease in current liabilities are subtracted from net income

Expenses with no cash outflows are added back to net income (depreciation and/or
amortization expense are the only operating items that have no effect on cash flows in the
period)

Revenues with no cash inflows are subtracted from net income

Non operating losses are added back to net income

Non operating gains are subtracted from net income

Example: cash flow of Citigroup

Citigroup Cash Flow Statement

(all numbers in millions of US$)
Period ending
12/31/2007 12/31/2006 12/31/2005
Net income
21,538
24,589
17,046
Operating activities, cash flows provided by or used in:
Depreciation and amortization
2,790
2,592
2,747
Adjustments to net income
4,617
621
2,910
Decrease (increase) in accounts receivable
12,503
17,236
-Increase (decrease) in liabilities (A/P, taxes payable)
131,622
19,822
37,856
Decrease (increase) in inventories
---Increase (decrease) in other operating activities
(173,057)
(33,061)
(62,963)
Net cash flow from operating activities
13
31,799
(2,404)
Investing activities, cash flows provided by or used in:
Capital expenditures
(4,035)
(3,724)
(3,011)
Investments
(201,777)
(71,710)
(75,649)
Other cash flows from investing activities
1,606
17,009
(571)
Net cash flows from investing activities
(204,206)
(58,425)
(79,231)
Financing activities, cash flows provided by or used in:
Dividends paid
(9,826)
(9,188)
(8,375)
Sale (repurchase) of stock
(5,327)
(12,090)
133
Increase (decrease) in debt
101,122
26,651
21,204
Other cash flows from financing activities
120,461
27,910
70,349
Net cash flows from financing activities
206,430
33,283
83,311
Effect of exchange rate changes
645
(1,840)
731
Net increase (decrease) in cash and cash equivalents
2,882
4,817
2,407