Hey Friends.

Where to start? The Statement of Cash Flows is such an important activity report. In this blog series, hopefully you’ll gain an aerial view in terms of what the statement is all about and yet knowledge of enough detail to help you read the report in a practical sense relative to analysis of a company.

When preparing the major financial reports (balance sheet, income statement, statement of cash flows), there is a set order for preparation once an accounting period ends. The income statement must precede the balance sheet and the balance sheet precedes the statement of cash flows. The ending balance sheet’s retained earnings line includes the income for the period so the income report must be completed before the balance sheet. The statement of cash flows explains the changes in all balance sheet accounts from their start of the period balances to their ending balances. Thus, the end of period balance sheet must be completed before the statement of cash flow preparation.

The statement of cash flows is broken into three sections — cash flows from operating activities, cash flows from investing activities, cash flows from financing activities. To simplify our thinking about the statement of cash flows, consider your checkbook register. It shows the cash flows in and out and how the cash balance is changed by the inflows and outflows recorded in the register. Well, a company’s beginning balance sheet has a balance on the asset line called cash (and cash equivalents)  and an ending balance sheet has a balance on that line. What were the cash inflows and outflows during the accounting period that explain the change in the balance’s sheets cash amount?

While you and I just label the increases and decreases to cash in our check registers for our personal checking accounts, we don’t separate this personal activity as operating, investing and financing. However, a company is doing that very thing with regard to its statement of cash flows. Think of it this way to keep the check register theme purely for explanation purposes: each time a cash event increases or decreases cash in the check register of the company, the description of the event could have a parenthesis after the description that shows either (operating) or (investing) or (financing). At the end of an accounting period, all the items denoted (operating) would be put on the statement of cash flows under the operating section — all the items denoted (investing) under that section and all the items denoted (financing) under that section. Of course, common items would be tallied and presented in the appropriate cash flow statement section. For example, if a company made multiple stock buybacks (financing activity) across the accounting period, the cash spent on each would be summed and presented as a single line in the financing section of the statement of cash flows — as “repurchases of common stock” or other words descriptive of this event. Further, repurchasing stock would obviously mean a reduction (outflow) of cash. If the company had issued stock during the same period, it would also be a financing activity but one that would be an increase (inflow) to cash.

Next time, I’ll explain something about the accounting that is behind the scenes with regard to the statement of cash flows but is highly relevant to the user’s (investor’s) perspective and proper analysis of the statement. If you want a preview of sorts, search for and read on the direct and indirect methods of presenting the statement of cash flow.

See you then.

Paul