A company’s financial statements include two primary statements. The first is the balance sheet, also known as the Statement of Financial Position. It contains a list of all the balances in a company’s financial records. Similarly, the second is the income statement, also known as the Statement of Profit or Loss. It includes a company’s revenues, expenses, and profits or losses.
These two statements are critical for any company and favorite for shareholders. However, both of these follow the accruals concept of accounting. According to this concept, companies must record revenues and expenses when they occur. Therefore, it ignores the cash element of these transactions and balances. However, the Statement of Cash Flows offers stakeholders a better view of a company’s cash position.
What is the Statement of Cash Flow?
The statement of cash flow is a financial statement that shows a company’s cash position. There are two methods that companies can use to prepare this statement. Most companies, however, prefer the indirect method of preparation. In this method, companies start with their net profits. After that, they adjust for non-cash expenses. Then, they calculate their cash flows operating, financing, and investing activities.
The statement of cash flows does not depend on the accruals concept in accounting. The other financial statements get affected by it. However, the statement of cash flows focuses on cash movements only.
In essence, it provides stakeholders with a view of the company’s cash transactions during the year. It does so by reconciling the opening cash balance to the closing cash balance.
The statement of cash flows is significantly helpful in providing stakeholders with more details into a company’s cash movements. Without this statement, stakeholders cannot determine how companies reached their closing cash and cash equivalent balances. It measures how well a company manages its cash position. From this, stakeholders can determine how a company can pay its debts, fund its operations, raise capital, etc.
Overall, the statement of cash flows summarizes the amount of cash and cash equivalents entering and leaving a company. It does not consider non-cash expenses that arise due to the accruals concept or other accounting standards. Apart from the net profit and non-cash expenses, there are three components of the statement of cash flows.
What are the components of the Statement of Cash Flows?
The statement of cash flows has three components. These include the cash flows from operating, investing, and financing activities. All three are crucial in helping companies provide a clear picture of their operations and other activities. A description of each of these components is as below.
Cash flows from Operating Activities
Cash flows from operating activities only include cash inflows and outflows that result from a company’s operations. It reflects how much cash a company generates or losses from its products and services. This component is usually the most comprehensive in the statement of cash flows. Usually, cash flows from operating activities will include the following items.
- Cash flows from account receivables.
- Cash flows from inventory.
- Cash flows from account payables.
- Interest payments.
- Income tax payments.
- Other operating expenses.
Companies can disclose each cash flow separately or categorize them under a common heading. For companies that primarily operate in the investments market, this section will also include receipts and payments for those investments.
Cash flows from Investing Activities
Cash flows from investing activities include cash inflows and outflows from the investments a company makes. However, a company does not necessarily need to trade stocks or other items.
This component may also include investments in fixed assets, sale of assets, provision on loan to third parties, etc. Cash flows from investing activities usually net off to cash outflows.
Cash flows from investing activities may coincide with cash flow from operating activities. As mentioned, if a company primarily operates in the investment market, then some items from this section will go to operating activities.
Cash flows from Financing Activities
Cash flows from financing activities primarily involve all cash inflows and outflows from a company’s financing sources. These usually include equity and debt. This component looks at payments due to or from shareholders, lenders or other similar parties. For example, dividends paid to shareholders are a financing activity.
Financing activities also consist of funds raised from financing sources. It may include shares issued from which a company receives cash or the issuance of bonds. Similarly, it will contain interest payments, etc.
What is Cash Flows from Investing Activities?
While cash flows from operating and financing activities are crucial, some stakeholders prefer cash flows from investing activities. This section usually reports on how much cash a company generated or lost on investment-related activities. For companies that invest in assets or are capital intensive, this section may contain a substantial activity level.
Stakeholders also view this section to determine how a company uses its finances. Cash flows from operating activities may include purchase/sale of assets, investment in securities, sale of securities, income from those sources, etc. Usually, cash flows from investing activities result in net cash outflow rather than inflow.
Despite being net cash outflows, investing activities do not worry stakeholders. The reason behind it is that these outflows usually enhance a company’s financial health. Similarly, it can indicate future positive performance. Therefore, stakeholders often look at this section to make decisions about the company’s future.
How is Investing Activity calculated and presented in the Statement of Cash Flows?
Calculating the cash flows from investing activities in the statement of cash flows is straightforward. It simply requires companies to identify all cash flows that will come under investing activities.
Once done, they must subtract any outflows and add any inflows to reach a net position. Sample cash flows from investing activities in the statement of cash flows may look as follows.
| Cash Flows from Investing Activities | Amount |
| Purchase of fixed assets | (XXXX) |
| Sales of fixed assets | XXXX |
| Purchase of investments (stocks or other securities) | (XXXX) |
| Sale of investments | XXXX |
| Lending money | (XXXX) |
| Collection of loans and insurance proceeds | XXXX |
In the above example, the purchase of fixed assets, investments, and lending money are cash outflows. In contrast, the other three items result in cash inflows. The aggregate amount from this calculation will result in a company’s total cash flows from investing activities.
Presentation-wise, the statement of cash flows has a specific format. It starts with a company’s net profit. Then, it adjusts for non-cash expenses. After that, it presents the cash flows from operating activities. The cash flows from investing activities come after operating activities. After that, it includes the cash flows from investing activities.
In the end, the statement also calculates an overall cash outflow or inflow for the period from all components. Once done, it adds or subtracts the value to the cash and cash equivalent opening balance to reach a closing balance. This balance will also match the cash and cash equivalent balance reported on the balance sheet.
Example
A company, ABC Co., bought assets of $100,000 in 2021. The company also sold another asset for $50,000. Similarly, ABC Co. invested in bonds worth $25,000 during the period. Lastly, the company also lent $75,000 to vendors with a view of collecting interest on it. Therefore, ABC Co. cash flows from investing activities in 2021 will be as follows.
| Cash Flows from Investing Activities | Amount |
| Purchase of fixed assets | $(100,000) |
| Sales of fixed assets | $50,000 |
| Purchase of bonds | $(25,000) |
| Lending money | $(75,000) |
| Net cash outflows from investing activities | $(150,000) |
Conclusion
The statement of cash flows illustrates a company’s cash activities during a specific period. It has three components, including cash flows from operating, investing, and financing activities.
Cash flows from investing activities usually involve the sale/purchase of assets, investment in/sale of securities, and loans paid/collected.
