Overview

The statement of cash flow reports the movement of cash into and out of your business in a given year. Cash is the lifeblood of your company. Cash includes currency, checks on hand, and deposits in banks. Cash equivalents are short-term, temporary investments such as treasury bills, certificates of deposit, or commercial paper that can be quickly and easily converted to cash.

Your business will use cash to pay bills, repay loans, and make investments, allowing you to provide goods and services to your customers. Your company will use cash to generate even more cash as a result of higher profits. The cash flow statement reports your business’ sources and uses of cash and the beginning and ending values for cash and cash equivalents each year. It also includes the combined total change in cash and cash equivalents from all sources and uses of cash.

It is imperative that you, the business owner, be able to successfully prepare a statement of cash flow. This discussion provides a detailed look into the various sections of a cash flow statement. It also describes two methods used to calculate cash flow from operating activities, indirect and direct with examples that will give you an edge when it comes time to prepare a cash flow statement of your own.

Background on a Cash Flow Statement

Before getting into the nuts and bolts of a statement of cash flow, let’s take a brief look at how this
document has evolved over the years. Originally, businesses were required to file a statement of changes in financial position, or funds statement. The funds statement went through several years of development before it was widely used. In 1961, Accounting Research Study No. 2, sponsored by the American Institute of Certified Public Accountants (AICPA), recommended that a funds statement be included with the income statement and balance sheet in annual reports to shareholders.

Two years later, Accounting Principles Board (APB) Opinion No. 3 was issued and provided funds statement preparation guidelines. Although Opinion No. 3 did not go so far as to make the funds statement mandatory, most businesses, aware of the statement’s value, included it in their annual reports anyway. Finally in 1971, APB Opinion No. 19 officially made the funds statement one of the three primary financial documents required in annual reports to shareholders. The APB also said a funds statement must be covered by the auditor’s report. Because Opinion No. 19 didn’t specify a particular format for the funds statement, businesses still enjoyed considerable flexibility in how they chose to report their funds flow information.

That flexibility came to an end in late 1987, with the Financial Accounting Standards Board’s (FASB) issuance of Statement No. 95, which called for a statement of cash flows to replace the more general funds statement. Additionally, the FASB, in an effort to help investors and creditors better predict future cash flow, specified a universal statement format that highlighted cash flow from operating, investing, and financing activities. This format is still used today.

To be continued …