What is a Statement of Cash Flows?

The statement of cash flows is one 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. It can present a more reliable view of the financial health of a business than the income statement, since the income statement can show profits when a business does not have enough cash to support its continuing operations.

What is the Purpose of the Statement of Cash Flows?

The purpose of the statement of cash flows is to present cash inflows and outflows for a reporting period to the reader of the report. These inflows and outflows are further classified into operating, investing, and financing activities. The information is used by the investment community to discern the ability of an organization to generate cash, and how the funds are then used.

Cash flows are not readily apparent when just reviewing the income statement, especially when that document is created under the accrual basis of accounting. Accrual accounting requires that certain non-cash revenue and expense items be included in the income statement, possibly in substantial amounts. A large disparity between the amount of reported income and the net change in cash flows could indicate that there is fraud in the preparation of a company's financial statements.

The statement of cash flows is particularly important when an acquirer is reviewing the financial statements of a potential acquiree. The acquirer does not want to pay a price that cannot be supported by the cash flows of the acquiree, so it uses the statement in order to confirm the amount of cash flows generated.

The statement also reveals the sources and uses of certain cash flows, which would not otherwise be readily apparent to the reader. These line items include changes in each of the current asset accounts, as well as the amount of income taxes paid.

The statement of cash flows is part of the financial statements, which also include the income statement and balance sheet.

Presentation of the Statement of Cash Flows

The statement of cash flows can be presented using the indirect method or the direct method. The indirect method is almost universally used, since it can be derived from a reporting entity’s existing chart of accounts without any modifications. An example of the indirect method of presentation appears in the following exhibit, where cash flows are organized into cash flows from operations, cash flows from investing activities, and cash flows from financing activities.