What is the purpose of statement of cash flows? According to the Financial Accounting Standards Board, the purpose of the statement of cash flows is to provide information about cash receipts and payments. Information about the operating, investing and financing activities of a business is provided as well. It is part of the accounting services that we provide.
The statement of cash flows is required in the annual report and should aid users to:
- Assess the probability of positive future cash flows.
- Assess the ability to meet financial obligations.
- Assess the reasons for difference between income and cash.
- Assess the cash and non-cash aspects of financing transactions.
The statement of cash flows is composed of three major sections:
- Cash flows from operating activities.
- Cash flows from investing activities.
- Cash flows from financing activities.
Cash flows from operating activities consist of cash effects of transactions that determine income. Examples of cash inflows from operating activities are cash sales, customer collections on account, interest income and dividend income. Examples of cash outflows from operating activities are paying suppliers of merchandise, paying suppliers of operating expense items, employee wages, interest expense, and taxes.
Cash flows from investing activities include lending activities, securities transactions, acquisition and sale of productive assets. The financing section appears last in the statement of cash flows. Cash flows from financing activities include transactions related to obtaining resources from the owners and creditors. In other words, financing activities relate to obtaining equity capital, dividend payment to stockholders, debt issuance, and repayment of bonds.
When a cash receipt or cash payment is for more than one activity, classification is based on the activity that is the prime reason for that cash flow. For instance, the purchase and sale of equipment to be used by the company is often deemed as an investing purpose. Emphasis is placed on explaining the change in cash and cash equivalents for the year. In general, a cash equivalent is a very liquid short term investment that has an initial maturity date of 3 months or less.