Statement of Cash Flows: Operating, Investing, and Financing
The statement of cash flows explains the change in cash over a period by classifying cash flows into three sections. Operating activities include cash from customers and payments to suppliers and employees-essentially the cash effects of transactions that enter net income. Investing activities include purchases and sales of long-term assets and investments, plus lending and collecting principal on loans. Financing activities include issuing and repaying debt, issuing and repurchasing stock, and paying dividends.
The statement can be prepared using the direct method (listing gross cash receipts and payments) or the indirect method (starting with net income and adjusting for non-cash items and changes in working capital). The indirect method is far more common on exams.
Indirect-method rules: Start with net income. Add back non-cash expenses (depreciation, amortization, bad debt expense). Subtract gains and add back losses on asset sales (the full cash proceeds appear in investing). Then adjust for working-capital changes: an increase in a current asset (e.g., accounts receivable, inventory, prepaid expenses) subtracts; an increase in a current liability (e.g., accounts payable, accrued liabilities) adds. Reverse for decreases.
Traps: (1) Including dividends paid in operating activities-they belong in financing. (2) Reporting the entire proceeds from an asset sale as an operating inflow-only the gain/loss adjustment belongs in operating; proceeds go to investing. (3) Misclassifying interest paid (operating under U.S. GAAP) and interest/dividends received (operating). (4) Forgetting that a stock dividend or stock split is non-cash and does not appear. (5) Treating a decrease in accounts payable as an addition.
Worked example: Net income $80,000; depreciation $15,000; gain on sale of equipment $5,000; accounts receivable increased $10,000; accounts payable decreased $4,000. Cash from operations = 80,000 + 15,000 − 5,000 − 10,000 − 4,000 = $76,000.