The cash flow statement is one of the main financial statements of a business or a nonprofit entity. (It is also known as the statement of cash flows.) The cash flow statement reports a company's major sources and uses of cash during the same period of time as the company's income statement. In other words, it lists the major reasons for the change in a company's cash and cash equivalents reported on the balance sheets at the beginning and the end of the accounting period.
The cash flow statement is needed because the income statement reports the revenues earned and the expenses incurred using the accrual method of accounting. These amounts are different from the amount of cash received and paid. Also, the company's annual income statements might report 3% of a new building's cost as depreciation expense, but the company may have paid cash for 100% of the building's cost in the year it was constructed. Since cash is critical for a company's operations and decision making, it is necessary to have the cash flow statement.
The cash flow statement is organized into four major sections: cash from operating activities, cash from investing activities, cash from financing activities, and supplemental information such as interest paid, income taxes paid, and significant noncash exchanges.
In the statement of cash flows, interest paid will be reported in the section entitled cash flows from operating activities.
Since most companies use the indirect method for the statement of cash flows, the interest expense will be "buried" in the corporation's net income. Net income will be the first item listed in the section cash flows from operating activities and will then be adjusted to the cash amount.
The amount of interest paid must also be disclosed. This is usually done as supplementary information at the end of the statement of cash flows or in the notes to the financial statements.
Now let's follow the indirect method of preparing the operating activities section of the statement of cash flows. We begin with the net income for the year, which was a negative Rs.75,000. Next we add the depreciation expense of Rs.100,000 because the depreciation expense reduced net income but did not use cash. Then we add the decrease in accounts receivable. A decrease in accounts receivable indicates that the company collected more cash than the amount of its current year's sales. Lastly, the increase in accounts payable is added. The increase in accounts payable indicates that the company paid out less cash than the amount of expenses shown on the income statement.
The total of the above amounts, (75,000) + 100,000 + 10,000 + 7,000 is a positive net cash flow from operating activities of Rs.42,000.
If a company issues stocks or bonds for cash and then pays off the debt, the transaction is reported in the financing section of the statement of cash flows.
If the transaction is a direct conversion of debt to equity (shares of stock) or debt to bonds and no cash receipts or cash payments occur, the transaction is to be disclosed as supplementary information.
The major cash flows are presented in one of these classifications:
The net change from these three classifications also explains the major reasons for the change in the company's cash and cash equivalents between two balance sheet dates.
In addition to the cash amounts being reported as operating, investing, and financing activities, the cash flow statement is required to disclose other information, including the amount of interest paid, the amount of income taxes paid, and any significant investing and financing activities which did not require the use of cash.
Basically, the cash from operating activities includes the company's cash flows except for those reported as cash flows from 1) investing activities (buying and selling property, plant and equipment, buying and selling long-term investments), and 2) financing activities (borrowing and repaying short-term and long-term debt, issuing and buying back shares of stock, paying dividends).