Cash flow statement
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| Statement of Cash Flow - Simple Example for the period 12/31/2005 to 12/31/2006 |
|
|---|---|
| Cash flow from operations | $4,000 |
| Cash flow from investing | $(1,000) |
| Cash flow from financing | $(2,000) |
| Net increase (decrease) in cash | $1,000 |
In financial accounting, a cash flow statement or statement of cash flows is a financial statement that shows a company's incoming and outgoing money (sources and uses of cash) during a time period (often monthly or quarterly). The statement shows how changes in balance sheet and income accounts affected cash and cash equivalents, and breaks the analysis down according to operating, investing, and financing activities. As an analytical tool the statement of cash flows is useful in determining the short-term viability of a company, particularly its ability to pay bills. International Accounting Standard 7 (IAS 7), is the International Accounting Standard that deals with cash flow statements.
People and groups interested in cash flow statements include
- accounting personnel, who need to know whether the organization will be able to cover payroll and other immediate expenses
- potential lenders or creditors, who want a clear picture of a company's ability to repay
- potential investors, who need to judge whether the company is financially sound
- potential employees or contractors, who need to know whether the company will be able to afford compensation
Contents |
[edit] Purpose
The cash flow statement was previously known as the statement of changes in financial position or flow of funds statement.[1] The cash flow statement reflects a firm's liquidity or solvency.
The balance sheet is a snapshot of a firm's financial resources and obligations at a single point in time, and the income statement summarizes a firm's financial transactions over an interval of time. These two financial statements reflect the accrual basis accounting used by firms to match revenues with the expenses associated with generating those revenues. The cash flow statement includes only inflows and outflows of cash and cash equivalents; it excludes transactions that do not directly affect cash receipts and payments. These noncash transactions include depreciation and write-offs on bad debts.[2] The cash flow statement is a cash basis report on three types of financial activities: operating activities, investing activities, and financing activities. Noncash activities are usually reported in footnotes.
The cash flow statement is intended to[3]
- provide information on a firm's liquidity and solvency and its ability to change cash flows in future circumstances
- provide additional information for evaluating changes in assets, liabilities and equity
- improve the comparability of different firms' operating performance by eliminating the effects of different accounting methods
- indicate the amount, timing and probability of future cash flows
The cash flow statement has been adopted as a standard financial statement because it eliminates allocations which might be derived from different accounting methods, such as various timeframes for depreciating fixed assets.[4]
[edit] History and variations
Cash basis financial statements were common before accrual basis financial statements. The "flow of funds" statements of the past were cash flow statements.
In the United States in 1971, the Financial Accounting Standards Board (FASB) defined rules that made it mandatory under Generally Accepted Accounting Principles (US GAAP) to report sources and uses of funds, but the definition of "funds" was not clear. "Net working capital" might be cash or might be the difference between current liabilities and current assets. From the late 1970 to the mid-1980s, the FASB discussed the usefulness of predicting future cash flows.[5] In 1987, FASB Statement No. 95 (FAS 95) mandated that firms provide cash flow statements.[6] In 1992, the International Accounting Standards Board issued International Accounting Standard 7 (IAS 7), Cash Flow Statements, which became effective in 1994, mandating that firms provide cash flow statements.[7]
US GAAP and IAS 7 rules for cash flow statements are similar. Differences include
- IAS 7 requires that the cash flow statement include changes in both cash and cash equivalents. US GAAP permits using cash alone or cash and cash equivalents.[8]
- IAS 7 permits bank borrowings (overdraft) in certain countries to be included in cash equivalents rather than being considered a part of financing activities.[9]
- IAS 7 allows interest paid to be included in operating activities or financing activities. US GAAP requires that interest paid be included in operating activities.[10]
- US GAAP (FAS 95) requires that when the direct method is used to present the operating activities of the cash flow statement, a supplemental schedule must also present a cash flow statement using the indirect method. The IASC strongly recommends the direct method but allows either method. The IASC considers the indirect method less clear to users of financial statements. Cash flow statements are most commonly prepared using the indirect method, which is not especially useful in projecting future cash flows.[11]
[edit] Cash flow activities
The cash flow statement is partitioned into cash flow resulting from operating activities, cash flow resulting from investing activities, and cash flow resulting from financing activities.
[edit] Operating activities
Operating activities include the production, sales and delivery of the company's product as well as collecting payment from its customers. This could include purchasing raw materials, building inventory, advertising and shipping the product.
Under IAS 7, operating cash flows include[12]
- receipts from the sale of goods or services
- receipts for the sale of loans, debt or equity instruments in a trading portfolio
- interest received on loans
- dividends received on equity securities
- payments to suppliers for goods and services
- payments to employees or on behalf of employees
- tax payments
- interest payments (alternatively, this can be reported under financing activities in IAS 7, but not in US GAAP)
- payments for the sale of loans, debt or equity instruments in a trading portfolio
Items which are added back to the net income figure (which is found on the Income Statement) to arrive at cash flows from operations generally include:
- Depreciation (loss of tangible asset value over time)
- Deferred tax
- Amortization (loss of intangible asset value over time)
- Any gains or losses associated with an asset sale (unrealized gains/losses are also added back from the income statement)
[edit] Investing activities
Investing activities focus on the purchase of the long-term assets a company needs in order to make and sell its products, and the selling of any long-term assets.
Under IAS 7, investing cash flows include[13]
- collections on loan principal and sales of other firms' debt instruments
- investment returns from other firms' equity instruments, including sale of those instruments
- receipts from sale of plant and equipment
- expenditure for purchase of plant and equipment
- loans made and acquisition of other firms' debt instruments
- expenditure for purchase of other firms' equity instruments (unless held for trading or considered cash equivalents)
Items under investing activities include:
- Capital expenditures, which include purchases (and sales) of property, plant and equipment
- Investments
[edit] Financing activities
Financing activities include the inflow of cash from investors such as banks and shareholders, as well as the outflow of cash to shareholders as dividends as the company generates income. Other activities which impact the long-term liabilities and equity of the company are also listed in the financing activities section of the cash flow statement.
Under IAS 7, financing cash flows include[14]
- proceeds from issuing shares
- proceeds from issuing short-term or long-term debt
- payments of dividends
- payments for repurchase of company shares
- repayment of debt principal, including capital leases
- for non-profit organizations, receipts of donor-restricted cash that is limited to long-term purposes
Items under the financing activities section include:
- Dividends paid
- Sale or repurchase of the company's stock
- Net borrowings
[edit] Disclosure of noncash activities
Under IAS 7, noncash investing and financing activities are disclosed in footnotes to the financial statements. Under US GAAP, noncash activities may be disclosed in a footnote or within the cash flow statement itself. Noncash financing activities may include[15]
- leasing to purchase an asset
- converting debt to equity
- exchanging noncash assets or liabilities for other noncash assets or liabilities
- issuing shares in exchange for assets
[edit] Preparation methods
The direct method of preparing a cash flow statement results in a more easily understood report.[16] The indirect method is almost universally used, because FAS 95 requires a supplementary report similar to the indirect method if a company chooses to use the direct method.
[edit] Direct method
The direct method for creating a cash flow statement reports major classes of gross cash receipts and payments. Under IAS 7, dividends received may be reported under operating activities or under investing activities. If taxes paid are directly linked to operating activities, they are reported under operating activities; if the taxes are directly linked to investing activities or financing activities, they are reported under investing or financing activities.
Sample cash flow statement using the direct method[17]
| Cash flows from operating activities | ||
| Cash receipts from customers | $27,500 | |
| Cash paid to suppliers and employees | (20,000) | |
| Cash generated from operations (sum) | 7,500 | |
| Interest paid | (2,000) | |
| Income taxes paid | (2,000) | |
| Net cash flows from operating activities | $3,500 | |
| Cash flows from investing activities | ||
| Proceeds from the sale of equipment | 7,500 | |
| Dividends received | 3,000 | |
| Net cash flows from investing activities | 10,500 | |
| Cash flows from financing activities | ||
| Dividends paid | (12,000) | |
| Net cash flows used in financing activities | (12,000) | |
| . | ||
| Net increase in cash and cash equivalents | 2,000 | |
| Cash and cash equivalents, beginning of year | 1,000 | |
| Cash and cash equivalents, end of year | $ 3,000 | |
[edit] Indirect method
The indirect method uses net-income as a starting point, makes adjustments for all transactions for non-cash items, then adjusts for all cash-based transactions. An increase in an asset account is subtracted from net income, and an increase in a liability account is added back to net income. This method converts accrual-basis net income (loss) into cash flow by using a series of additions and deductions.[18]
[edit] Rules
The following rules are used to make adjustments for changes in current assets and liabilities, operating items not providing or using cash and nonoperating items.[19]
- Decrease in noncash current assets are added to net income
- Increase in noncash current asset are subtracted from net income
- Increase in current liabilities are added to net income
- Decrease in current liabilities are subtracted from net income
- Expenses with no cash outflows are added back to net income
- Revenues with no cash inflows are subtracted from net income (depreciation expense is the only operating item that has no effect on cash flows in the period)
- Nonoperating losses are added back to net income
- Nonoperating gains are subtracted from net income
Citigroup Incorporated cash flow example:[20][21][22]
| Citigroup Cash Flow Statement (all numbers in thousands) |
|||
| Period ending | 12/31/2006 | 12/31/2005 | 12/31/2004 |
| Net income | 21,538,000 | 24,589,000 | 17,046,000 |
| Operating activities, cash flows provided by or used in: | |||
| Depreciation and amortization | 2,790,000 | 2,592,000 | 2,747,000 |
| Adjustments to net income | 4,617,000 | 621,000 | 2,910,000 |
| Decrease (increase) in accounts receivable | 12,503,000 | 17,236,000 | -- |
| Increase (decrease) in liabilities (A/P, taxes payable) | 131,622,000 | 19,822,000 | 37,856,000 |
| Decrease (increase) in inventories | -- | -- | -- |
| Increase (decrease) in other operating activities | (173,057,000) | (33,061,000) | (62,963,000) |
| Net cash flow from operating activities | 13,000 | 31,799,000 | (2,404,000) |
| Investing activities, cash flows provided by or used in: | |||
| Capital expenditures | (4,035,000) | (3,724,000) | (3,011,000) |
| Investments | (201,777,000) | (71,710,000) | (75,649,000) |
| Other cash flows from investing activities | 1,606,000 | 17,009,000 | (571,000) |
| Net cash flows from investing activities | (204,206,000) | (58,425,000) | (79,231,000) |
| Financing activities, cash flows provided by or used in: | |||
| Dividends paid | (9,826,000) | (9,188,000) | (8,375,000) |
| Sale (repurchase) of stock | (5,327,000) | (12,090,000) | 133,000 |
| Increase (decrease) in debt | 101,122,000 | 26,651,000 | 21,204,000 |
| Other cash flows from financing activities | 120,461,000 | 27,910,000 | 70,349,000 |
| Net cash flows from financing activities | 206,430,000 | 33,283,000 | 83,311,000 |
| Effect of exchange rate changes | 645,000 | (1,840,000) | 731,000 |
| Net increase (decrease) in cash and cash equivalents | $2,882,000 | $4,817,000 | $2,407,000 |
[edit] See also
[edit] Notes and references
- ^ Bodie, Zane; Alex Kane and Alan J. Marcus (2004). Essentials of Investments, 5th ed. McGraw-Hill Irwin, 455. ISBN 0072510773.
- ^ Epstein, Barry J.; Eva K. Jermakowicz (2007). Interpretation and Application of International Financial Reporting Standards. John Wiley & Sons, 91-97. ISBN 9780471798231.
- ^ Epstein, pp.90-91.
- ^ Epstein, p. 91.
- ^ Epstein, p. 90.
- ^ Bodie, p.454.
- ^ Epstein, p. 88
- ^ Epstein, p. 91.
- ^ Epstein, p. 92.
- ^ Epstein, p. 93.
- ^ Epstein, p. 97.
- ^ Epstein, p. 93.
- ^ Epstein, p. 93.
- ^ Epstein, p. 93.
- ^ Epstein, p. 93.
- ^ Epstein, p. 95.
- ^ Epstein, p. 101
- ^ Epstein, p. 94.
- ^ Wild, John Paul. Fundamental Accounting Principles, 18th edition, New York: McGraw-Hill Companies, p. 630-633. ISBN 0-07-299653-6.
- ^ Yahoo finance report on Citigroup
- ^ Citigroup finance report
- ^ Bodie, p. 455.
