Cash Flow Statement

Cash Flow Statement Preparation and Analysis

If you are running a business it is a common occurrence that you will need to present financial statements to a bank or perhaps a lender or investor and at times as a public company to shareholders. One of the three basic financial statements besides the balance sheet and income statement is the cash flow statement, which is also called the Statement of Cash Flows.



If you are going to be responsible for preparing it yourself it will be important to first resolve whether you will be using the direct method or indirect method to prepare the cash flow statement. You will also need a copy of prior years balance sheet as well as the current years balance sheet. That is because the cash flow statement is used to analyze the differences between accrual-based balances and the activity that directly affects cash.

The direct method of preparation will simply present the cash based revenue and expense which will result in a change to cash. As the name suggests it is very direct in only stating items that either use or generate cash.

The indirect method takes the net income form the accrual based financial statements and adjusts it to only include items that change cash. So expenses that where the result of accrual based accounting will be flushed out and will result in either increases or decrease in those balance sheet accounts.

If you are not sure of the

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difference between the two methods of preparing the statement of cash flows it will be worthwhile to search the internet for templates or samples in order to prepare your first one. Do not rely solely on automatically generated reports from your accounting software for it is likely that those will not be complete.

Statement of Cash Flows Benefits

Even if you will never prepare a cash flow statement is important that you understand it's significance and the story that tells better then either the balance sheet or income statement. Because financial reporting that is prepared according to GAAP is generally done on the accrual basis there is the possibility that financial statements might look better then the business is actually doing. A careful analysis of the cash flow statement will flush out possible manipulations, exaggerations or items that may hamper the long-term viability of the company.

Cash Flow Statement Components

There are three components of the cash flow statement. The first component is known as operations. The operations component of the cash flow statement begins with net income and then adjusts for non-cash items. Some of the most common non-cash items are depreciation as well as changes in accounts receivable and accounts payable.

Generally a second component of the cash flow statement is investing. This shows the effect of investments in fixed assets and other long-term assets on cash flow. It is important to segregate one time investments from those that are a regular course of business. That is because a savvy reader of the cash flow statement will be trying to predict if the business is going to be using cash are generating cash in the future.

The other component is financing. This will include cash generated by new infusions of capital from shareholders or investors as well as distributions of cash to owners. The financing section can be very revealing of how the business is obtaining the cash that it needs when it is not being generated by operations.

What is the benefit of financial statements with a cash flow statement over those without?

The major benefit of a cash flow statement is the ability to see what has changed on the balance sheet in the last year. For an example of the significance of this we could look at investments in fixed assets. Most any business will have fixed assets and that in of itself is not an issue. However there are some businesses that require constant upgrades to fixed assets on a regular basis. This could reuire more significant investments of capital than a business that can rely on it's past purchased fixed assets to sustain it for many years. Simply looking at the balance sheet of one year will not allow you to make such a distinction. However on the statement of cash flows expenditures for fixed assets will be defined and analysis can be done in order to ask some refined questions.


What do to if not offered a cash flow statement?

If you are not offered a cash flow statement with the financial statements you are reading there is a good second choice. Simply ask for the prior years balance sheet, in fact often two years balance sheet's are presented together. Then simply line up accounts and calculate the differences. In our example of fixed assets this test would expose whether significant fixed assets where purchased in the last year or not.


Is two years balance sheets the equivalent of a cash flow statement?

Sometimes it is and sometimes not. If there are significant non cash disclosures then they may be presented on a cash flow statement but may not be evident when comparing two years of balance sheets. So if you are in a position to demand a copy it would be in your best interest to ask for it. You would be in good company if you did demand it, such savvy investors such as Warren Buffett always require a cash flow statement along with their financial statements.