As discussed in another article, the income statement provides a measure of an organization’s performance in generating net assets. Because net assets are claims on cash, the income statement doesn’t measure the organization’s performance in generating cash directly. Many businesses with strong income statements have gone bankrupt because they were unable to come up with the cash needed to meet their obligations.
Cash is vital to organizations. Creditors must be paid in cash and businesses are usually formed in order to return cash the owners. The statement of cash flows (or cash flow statement) provides decision makers with a financial statement that focuses on cash. A cash flow statement reports cash receipts and cash payments of an organization during a particular time period. Both cash flow and income statements report activities over a span of time.
The basic concept of a cash flow statement is simple:
- Activities that increased cash (cash inflows) and those that decreased cash (cash outflows) are listed
Each cash inflow and outflow are categorized into one of three corresponding categories:
- Operating activities: Transactions affecting the sale, purchase, or production of goods and services.
- Investing activities: Include acquiring and selling of long-term assets and securities held for long-term investment reasons.
- Financing activities: Include acquiring and selling resources from owners and creditors and repaying these amounts.
Below is an example of a cash flow statement for a fictitious enterprise called ABC Company Inc. The statement is broken up into three main areas – operating, investing and financing activities. The net increase in cash is shown at the bottom of the income statement.