Definitions

noncash

Cash flow statement

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 flow of cash. The money coming into the business is called cash inflow, and money going out from the business is called cash outflow. The statement shows how changes in balance sheet and income accounts affect cash and cash equivalents, and breaks the analysis down 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

Purpose

The cash flow statement was previously known as the statement of changes in financial position or flow of funds statement. 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 or write-offs on bad debts to name a few. 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

  1. provide information on a firm's liquidity and solvency and its ability to change cash flows in future circumstances
  2. provide additional information for evaluating changes in assets, liabilities and equity
  3. improve the comparability of different firms' operating performance by eliminating the effects of different accounting methods
  4. 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.

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

  • 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

Preparation methods

The direct method of preparing a cash flow statement results in a more easily understood report. 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.

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

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

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.

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.

  • 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:

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

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