Statement of cash flows and the purpose of its preparation

The term cash flows refers to the receipts and payments of cash. Companies periodically disclose their cash flows arising from various activities in the form of a statement. This statement is known as statement of cash flows (or cash flow statement).

The statement of cash flows (SCF) is an important financial statement that shows the details of the company’s cash flows for an accounting period. It tells the users of the statement how much cash has been received or paid by a business during its accounting period. In addition, it reveals the sources (i.e., how the cash has been generated) and disbursement of cash (i.e., how the cash has been utilized) during the reporting period.

A company’s total cash flows during its accounting period is generally categorized as operating, investing and financing cash flows. To properly report these three types of cash flows, the statement of cash flows is divided into three sections – operating activities section, investing activities section, and financing activities section. (Read ‘three sections of the statement of cash flows’ article).

The presentation of SCF is mandatory for the companies that are required to prepare and present their financial statements in accordance with IFRSs and GAAPs.

Purposes of the statement of cash flows (SCF)

The main purposes of preparing a statement of cash flows are as follows:

(1). Explanation of the changes in cash:

SCF explains the reasons of the change in company’s cash and cash equivalents during a particular accounting period by showing the details of cash generated and cash used to perform operating, investing and financing activities of the business.

(2). Anticipation of future cash flows:

The management, creditors, actual and perspective investors and competitors of the company are interested to know the ability of the company to generate positive cash flows in future. The SCF enables these parties to understand how company manages cash and to anticipate the impact of current cash receipts and cash disbursements on future cash flows and operational performance of the business.

(3). Legal requirements:

In some countries, the companies are legally required to prepare and present financial statements in accordance with international financial reporting standards (IFRSs) or GAAPs. As the statement of cash flows (SCF) is one of the basic components of financial statements, its presentation is legally required in many countries, including USA.

(4). Information about non-cash investing and  financing activities:

Companies also engage in various investing and financing activities that do not require the use of cash. Such activities are known as non-cash investing and financing activities. These activities may have a significant impact on the future cash flows and profitability of the entity and therefore their disclosure to the users of financial statements becomes necessary. For this purpose, a company that performs any significant non-cash investing and financing activity during the accounting period must disclose it either in a separate schedule or in the footnotes to the SCF.

The examples of non-cash investing and financing activities that may become significant for a company and its stakeholders are given below:

• Purchase of land for issuing common stock.
• Issuance of common stock to discharge a liability.
• Purchase of equipment for issuing a note.

(5). The difference between net income and net cash flows from operating activities:

A careful review of SCF reveals the reasons of the difference between the net income and the related net cash flows from operating activities.