Cash Flow Statement

Cash Flow Definition

The cash flow statement, also called the statement of cash flows, summarizes the cash inflows and cash outflows from operating, investing, and financing activities for the reporting period indicated (e.g. a month, a quarter, or a year).

The cash flow statement is a required financial statement in addition to the income statement, the balance sheet, and the statement of stockholders equity.

Recall that the income statement reports revenue under the accrual accounting method. This means that sales that were made for the period were not necessarily made in cash. Similarly, any expenses incurred during the reporting period were not necessarily paid with cash.

The cash flow statement shows the actual flow of cash received and spent during the reporting period. It therefore uses the cash basis of accounting. Since the other financial statements use the accrual method, the statement of cash flows reconciles the financial statements to cash by identifying the actual cash paid for expenses, and the actual cash received for revenue.

The Cash Flow Statement and the Income Statement

The income statement summarizes the flow of business activity for the reporting period (a month, a quarter, or a year). This flow of business activity is categorized into revenue and expenses to determine net income.

Similarly, the cash flow statement summarizes the flow of cash activity for the reporting period. This flow of activity is categorized into inflows and outflows to determine the net cash increase or decrease. The income statement and the cash flow statement are therefore very similar in that they summarize the flow of activity for a certain period of time to determine the net result.

The Cash Flow Statement and the Balance Sheet

The accounting balance sheet shows us a “snapshot” of the results of that business activity frozen at certain point in time, including the cash balance. The net change in cash on the cash flow statement accounts for the change in the cash balance from one period to another on the balance sheet.

From these statements, we can develop a clearer picture of the financial health of the business. For example, even if a company is highly profitable compared to industry averages and competition, if the profits are not easily converted to cash, the business may have problems paying for inventory, bills, and staying afloat. It is therefore essential that the profit and loss statement is examined with the cash flow report and the balance sheet to develop a complete picture of the business.

The Cash Flow Statement Includes Cash and Cash Equivalents

According to Generally Accepted Accounting Principles (GAAP), the statement of cash flows must include cash and cash equivalents. Cash equivalents are defined as short-term, highly liquid investments that are readily convertible to known amounts of cash.

Because cash equivalents are so near their maturity dates, they present an insignificant risk of changing in value. Generally, only investments with original maturities of three months or less qualify as cash equivalents (FASB Statement No. 95).

Examples of cash equivalents

Treasury Bills Money Market Funds Commercial Paper (short-term loans) Certificates of Deposit