Sections of the statement of cash flows
Companies categorize their cash flows into operating, investing, and financing cash flows. When a statement of cash flows is prepared, these three types of cash flows are reported under separate sections, which are the operating activities section, the investing activities section, and the financing activities section. This categorization helps investors and other users of financial statements understand how the cash was received and how it was paid as the company engaged in various operating, investing, and financing activities to conduct business during a particular reporting period.
Sections of the statement of cash flows:
As described above, the statement of cash flows consists of three sections, which are briefly discussed below:
(1). Operating activities section:
The operating activities section shows the cash flows that arise from operating activities the company engages in during its reporting period. These activities include the company’s principle revenue generating activities plus other activities that are not investing or financing activities in nature. In other words, the receipts and payments of cash that occur as a result of revenue and expense transactions are shown under this section. Following are some examples of operating activities that affect a company’s cash flow:
Examples of cash inflow from operating activities:
- Cash receipts from customers.
- Interest income received in cash.
- Dividend income received in cash.
- Cash received as a result of the settlement of a litigation matter.
Examples of cash outflow from operating activities:
- Cash payment to suppliers for the purchase of merchandise or raw materials.
- Cash payment for expenses such as interest, electricity bills, rent, salaries, wages, etc.
- Cash payment for income tax.
- Cash paid as a result of the settlement of a litigation matter.
The net cash flows from operating activities can be determined using either the direct or indirect method. While companies are mostly allowed to choose any of these two methods worldwide, major accounting frameworks, like GAAPs and IFRSs, suggest the use of the direct method.
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(2). Investing activities section:
Investing activities include the acquisition and disposal of long-term assets and investments in the form of shares, bonds, etc. The cash flows arising from such activities are shown under the investing activities section.
Students should keep in mind that both interest and dividend incomes earned by an entity from investment in other entities are considered operating activities under GAAPs. However, IFRSs permit companies to treat these incomes as either operating or investing activities, depending on their accounting policies and procedures.
Some examples of the cash flows from investing activities are given below:
Examples of cash inflow from investing activities:
- Proceeds from the sale of fixed assets, e.g., equipment, machinery, plants, etc.
- Proceeds from the sale of land.
- Proceeds from the sale of investments, e.g., shares and bonds of other companies, etc.
- Proceeds from the sale of intangible assets, e.g., patent copyright, etc.
- Repayment of the principle amount of loans and advances made to others.
- Cash receipts from future contracts.
Examples of cash outflow from investing activities:
- Cash paid to purchase fixed assets, e.g., equipment, machinery, plants, etc.
- Cash paid to purchase land.
- Loans and advances made to others.
- Cash paid to purchase investments, e.g., shares and bonds of other companies, etc.
- Cash spent on the research and development activities of the company.
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(3). Financing activities section:
Cash flows resulting from the financing activities of the company are shown under the financing activities section of the statement of cash flows. Financing activities mostly include those activities that change the size and composition of the equity (i.e., common or preferred stock) and the long-term liabilities (i.e., long-term loans and borrowings) of the company. Besides this, short-term loans obtained from commercial banks or other financial institutions with the purpose of acquiring capital or funding the company’s business are also considered a financing activity.
Students need to remember that interest paid on loans or borrowings is not a financing activity under generally accepted accounting principles (GAAPs). Rather, it is an operating activity and is reported as such under GAAPs. However, under international financial reporting standards (IFRSs), a company can choose to report the amount of interest paid as either operating or financing activity.
The general examples of financing activities that affect a company’s cash are given below:
Examples of cash inflow from financing activities:
- Cash received from both short- and long-term loans and borrowings.
- Cash received from the issuance of common or preferred stock.
- Proceeds from sale of treasury stock
Examples of cash outflow from financing activities:
- Retirement of debts.
- Repayment of the principle amount of loans and borrowings.
- Payment of cash dividends to common and preferred stockholders.
- Cash paid to purchase treasury stock.
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Non-cash investing and financing transactions
If a company engages in one or more material non-cash investing and financing transactions during a reporting period, it must mention the details of those transactions either at the bottom of the statement of cash flows as a footnote or include them in the notes to the financial statements. This disclosure is mandatory under both GAAPs and IFRSs as it may impact the economic decisions of investors and other stakeholders.
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