Definition: a financial statement providing overview of cash inflows and outflows of a company during a specified period of time
The function of the statement of cash flows is to summarize the transactions that have affected the cash holdings of a company during a specified period.
Organizing cash flow transactions
A statement of cash flows categorizes all cash transactions into one of three types of activties:
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.
Two 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.