Statement of cash flows
Statement of cash flows (also known as the cash flow statement) is one of the principal financial statements that reports the cash inflows and cash outflows of an organization during an accounting period. It provides information about how cash and cash equivalents are generated and used through operating, investing, and financing activities, enabling users to assess an organization's liquidity, solvency, financial flexibility, and ability to generate future cash flows.
Unlike the Income statement, which is prepared on the accrual basis of accounting, the statement of cash flows reports actual cash movements during the reporting period. Consequently, it provides important information about an organization's cash-generating ability that cannot be obtained solely from measures of profitability.
The statement of cash flows is a fundamental component of Financial accounting, Financial reporting, Corporate finance, and Financial analysis. It is required under both International Financial Reporting Standards (IFRS) and Generally Accepted Accounting Principles (GAAP).
History
The statement of cash flows evolved from earlier funds flow statements as accounting standards increasingly emphasized the importance of cash-based financial information. Modern accounting standards require organizations to present a statement of cash flows as one of the primary financial statements to improve transparency and comparability.
Today, it forms an integral part of corporate financial reporting worldwide.
Objectives
The principal objectives of the statement of cash flows are to:
- report cash inflows and outflows;
- evaluate liquidity and solvency;
- assess financial flexibility;
- explain changes in cash balances;
- support investment and financing decisions;
- improve financial statement analysis.
These objectives assist investors, creditors, regulators, and other stakeholders in evaluating an organization's financial performance and cash management.
Structure
The statement of cash flows consists of three principal sections:
- operating activities;
- investing activities;
- financing activities.
Together, these sections explain the change in cash and cash equivalents during the reporting period.
Operating activities
Operating activities include cash flows arising from the organization's principal revenue-generating activities.
Examples include:
- cash received from customers;
- cash paid to suppliers;
- employee compensation;
- income taxes paid;
- interest received or paid, depending on the applicable accounting framework.
Cash flows from operating activities indicate the organization's ability to generate cash through its normal business operations.
Investing activities
Investing activities relate to the acquisition and disposal of long-term assets and investments.
Examples include:
- purchase of property, plant and equipment;
- sale of long-term assets;
- acquisition of subsidiaries;
- purchase or sale of investments;
- loans made to other entities.
Investing activities frequently include Capital expenditure.
Financing activities
Financing activities relate to changes in the organization's capital structure.
Examples include:
- issuing shares;
- borrowing funds;
- repayment of debt;
- payment of dividends;
- share repurchases.
These activities explain how the organization obtains and returns financial capital.
Methods
Cash flows from operating activities may be presented using:
- the direct method; or
- the indirect method.
The indirect method begins with net income and adjusts for non-cash items and changes in working capital, while the direct method reports major categories of cash receipts and cash payments.
Example
Suppose ABC Corporation reports the following cash flows:
| Activity | Cash flow |
|---|---|
| Operating activities | US$850 million |
| Investing activities | −US$250 million |
| Financing activities | −US$150 million |
The net increase in cash is:
Accordingly, cash and cash equivalents increase by US$450 million during the reporting period.
Relationship with income statement
The Income statement reports revenues and expenses using accrual accounting.
The statement of cash flows explains how those accounting results translate into actual cash receipts and cash payments.
Relationship with balance sheet
The Balance sheet reports the cash balance at the beginning and end of the reporting period.
The statement of cash flows explains the movements that reconcile those balances.
Relationship with free cash flow
Free cash flow is commonly derived using information reported in the statement of cash flows.
Operating cash flow and Capital expenditure reported in the statement are frequently used to calculate free cash flow.
Relationship with capital expenditure
Capital expenditure is generally reported within investing activities because it represents investment in long-term productive assets.
Higher capital expenditure typically results in larger investing cash outflows.
Relationship with depreciation
Depreciation is a non-cash expense.
Under the indirect method, depreciation is added back to net income because it reduces accounting profit without reducing cash during the reporting period.
Applications
The statement of cash flows is widely used in:
- financial reporting;
- investment analysis;
- credit analysis;
- corporate finance;
- business valuation;
- financial planning;
- liquidity management.
It is one of the principal tools used to evaluate an organization's financial health.
Advantages
The statement of cash flows provides several important benefits.
It measures actual cash generation, improves the assessment of liquidity and solvency, enhances financial transparency, supports investment and lending decisions, and assists in evaluating an organization's ability to finance operations, investments, and dividend payments.
It also complements the income statement and balance sheet by providing information unavailable from accrual accounting alone.
Limitations
The statement of cash flows does not directly measure profitability and may fluctuate because of temporary changes in working capital or investment timing. Cash flows may also vary significantly between reporting periods, making trend analysis more meaningful than isolated observations.
Interpretation should therefore be combined with other financial statements.
Importance
The statement of cash flows is one of the fundamental financial statements because it explains how an organization generates and uses cash. By providing information about operating, investing, and financing activities, it enables investors, creditors, regulators, and management to assess liquidity, financial flexibility, investment capacity, and long-term financial sustainability.