One of the most important financial statements used across organizations, the statement of cash flows illustrate the amount of cash a business has generated in a reporting period. Every business is required to prepare a statement of cash flows in its financial statement. The statement details the cash used in the period and helps management see where the money is going. 

The three parts of the statement of cash flow reflect on the financial performance of the organization.

One of the main reasons for a difference between profit and cash flow is that the income statement is prepared according to the accrual basis of account. In this form of accounting, the revenue and expenses for a period are matched, even if the revenue has not been collected or the expenses have not been paid for. Whereas in the cash flow statement, cash is recognized only when it is received or it has been disbursed.

There are three different parts in the statement and an optional supplemental section. The statement will show how much money was used or generated in the year. All three sections are extremely important for a business. Let us discuss them in detail.

Cash from operating activities

The first part of the statement is about the operating activities in an organization. It shows the cash received in the business and used in the operating activities.

It details the changes in the ledger account balance for current assets and liabilities. This part of the statement begins with the cash used for normal operating activities.

It includes accounts receivable, accounts payable, unearned revenues, and prepaid insurance. When there is a sale of products or services, the same is reported here. 

When reporting cash from operating activities, the indirect method is usually used. It starts with the net income of the company that is based on the accrual method.

This amount is then converted into cash from operating activities by adding back the expenses like depreciation and reporting for changes in accounts payable, accounts receivable, current assets, and current liabilities.

The exact formula varies for each company but there is a generic formula that is used:

Cash flow from operations= Net income of the organization + Non-cash items + Changes in working capital. 

Cash from investment activities

The second section of the statement of cash flows is about investment activity. The investments of the organization are listed in this section. It includes the purchase or sale of a property, plant, or equipment.

The section shows all the investments done for business purposes. The important ledger accounts are investment account, capital equipment account, vehicle, and land and buildings.

Any equipment purchased for regular business operations should be reflected here. It is important to note that the purchase or sale of equities or bonds is also reported in this section. 

Cash from financing activities 

There is some amount of confusion between cash from investment activities and cash from financing activities. This is the third section and it lists information about the financing activities of the company.

These activities include the purchase of stock or bonds, dividend payments, and repurchase of stock. The applicable ledger accounts include paid-in capital account, bonds payable, retained earnings, and stock account.

An investor can get insights into the stock and bond investment of an organization by looking at this segment. It also has details about dividend payments for prospective investors. 

Supplemental information

Although not a part of the cash flow statement but essential for completion of the statement, the supplemental information reflects the information related to interest earned on an interest-bearing account.

It includes additional details like the amount of income tax paid in a period. This section records any significant exchanges which did not involve a cash transaction. Many businesses do not record stock but if there is an interest bearing business bank account, its information should be shown here. 

At the end of the cash flow statement, the opening cash amount for the year is stated. After considering the effect of all the three sections of the statement, the closing amount will be shown.

This could be a positive or a negative amount and it will be carried forward to the balance sheet. It is important to note that negative cash flow does not mean a bad thing. 

The three sections of a statement cash flow share important and detailed information about the flow of cash in and out of an organization. However, it is important to remember that the cash flow statement is not the only financial statement that one should study.

It is important to consider all the statements in unison before making an investment decision. The cash flow statement will give clear insights into the movement of cash and about the liquidity of the organization. The statement is easy to read and comprehend because of the division into three sections. 

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