The statement of cash flows is a financial
statement listing the cash inflows and cash outflows for the
business for a period of time. Cash flow
represents the cash receipts and cash disbursements as a result of
business activity. The statement of cash flows enables users of the
financial statements to determine how well a company’s income
generates cash and to predict the potential of a company to
generate cash in the future.
Accrual accounting creates timing differences between income
statement accounts and cash. A revenue transaction may be recorded
in a different fiscal year than the year the cash related to that
revenue is received. One purpose of the statement of cash flows is
that users of the financial statements can see the amount of cash
inflows and outflows during a year in addition to the amount of
revenue and expense shown on the income statement. This is
important because cash flows often differ significantly from
accrual basis net income. For example, assume in 2019 that
Amazon showed a loss of
approximately $720 million, yet
Amazon’s cash balance increased
by more than $91 million. Much of the change can be explained by
timing differences between income statement accounts and cash
receipts and distributions.
A related use of the statement of cash flows is that it provides
information about the quality of a company’s net income. A company
that has records that show significantly less cash inflow on the
statement of cash flows than the reported net income on the income
statement could very well be reporting revenue for which cash will
never be received from the customer or underreporting expenses.
A third use of the statement of cash flows is that it provides
information about a company’s sources and uses of cash not related
to the income statement. For example, assume in 2019 that
Amazon spent $287 million on
purchasing fixed assets and almost $370 million acquiring other
businesses. This indicated to financial statement users that
Amazon was expanding even as it
was losing money. Investors must have thought that spending was
good news as Amazon was able to
raise more than $1 billion in borrowings or stock issuances in
2019.
ETHICAL CONSIDERATIONS
Cash Flow Statement Reporting
US generally accepted accounting principles (GAAP) has codified
how cash flow statements are to be presented to users of financial
statements. This was codified in Topic 230: Statement of Cash Flows
as part of US GAAP.1
Accountants in the United States should follow US GAAP. Accountants
working internationally must report in accordance with
International Accounting Standard (IAS) 7 Statement of Cash
Flows.2
The ethical accountant understands the users of a company’s
financial statement and properly prepares a Statement of Cash Flow.
There is often more than one way that financial statements can be
presented, such as US GAAP and International Financial Reporting
Standards (IFRS). What if a company under US GAAP showed reporting
issues on their financial statements and switched to IFRS where
results looked better. Is this proper? Does this occur?
The statement of cash flows identifies the sources of cash as
well as the uses of cash, for the period being reported, which
leads the user of the financial statement to the period’s
net cash flows, which is a method used to
determine profitability by measuring the difference between an
entity’s cash inflows and cash outflows. The statement answers the
following two questions: What are the sources of cash (where does
the cash come from)? What are the uses of cash (where does the cash
go)? A positive net cash flow indicates an increase in cash during
the reporting period, whereas a negative net cash flow indicates a
decrease in cash during the reporting period. The statement of cash
flows is also used as a predictive tool for external users of the
financial statements, for estimated future cash flows, based on
cash flow results in the past.
Approaches to Preparing the Statement of Cash Flows
The statement of cash flows can be prepared using the indirect
approach or the direct approach. The indirect
method approach reconciles net income to cash flows by
subtracting noncash expenses and adjusting for changes in current
assets and liabilities, which reflects timing differences between
accrual-based net income and cash flows. A noncash
expense is an expense that reduces net income but is not
associated with a cash flow; the most common example is
depreciation expense. The direct methodlists net
cash flows from revenue and expenses, whereby accrual basis revenue
and expenses are converted to cash basis collections and payments.
Because the vast majority of financial statements are presented
using the indirect method, the indirect approach will be
demonstrated within the chapter, and the direct method will be
demonstrated in
Appendix: Prepare a Completed Statement of Cash Flows Using the
Direct Method.
LINK TO LEARNING
AccountingCoach is a great resource for many
accounting topics, including cash flow issues.
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1 Financial Accounting Standards Board (FASB). “Statement
of Cash Flows (Topic 230) Classification of Certain Cash Receipts
and Cash Payments.” An Amendment of the FASB
Accounting Standards Codification. August 2016.
https://asc.fasb.org/imageRoot/55/95454355.pdf
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2 International Financial Reporting Standards (IFRS). “IAS
7 Statement of Cash Flows.” n.d.
www.ifrs.org/issued-standard...of-cash-flows/