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What is the Statement of Cash Flows?
Organizing cash flow transactionsA statement of cash flows categorizes all cash transactions into one of three types of activties:
1. Operating activities: The cash inflows and outflows related to core business operations.
2. Investing activities: Transactions involving the acquisition and sale of the long-term assets of the company, as well as non-operating investment assets.
3. Financing activities: Transactions including cash inflows and outflows between the company and its creditors and owners, i.e. the sale of stock for cash.
The three classifications prevent users of financial statements from making incorrect conclusions about a business, based on the total increase or decrease of cash during an accounting period.
Companies always seek positive cash flows, especially from operating activities. However, short-term negative cash flows from operating activities does not necessarily mean that the company isn't doing well.
Preparing the statement: The indirect or direct methodTwo different methods exist for preparing statements of cash flows: direct or indirect.
The indirect method begins with the net income of a company and then adjusts for all non-cash transactions followed by all cash transactions. Transactions that increase an asset account will be subtracted from the net income, while transactions increasing a liability account is added to the net income. When using the indirect method, accrual-basis net income (or loss) may be converted into cash flow through numerous additions and deductions.
The direct method more simply lists cash receipts and payments by their respective categories – cash inflows are listed as positive entries and cash outflows as negative entries.
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