A cash flow statement is a financial report that tells the reader the source of a company’s cash and how it was spent over a specified time period. This is an important indicator of financial soundness because it is possible for a company to show profits while not having enough cash to sustain operations. It also categorizes the sources and uses of cash to provide the reader with an understanding of the amount of cash a company generates and uses in its operations, as opposed to the amount of cash provided by sources outside the company, such as borrowed funds or funds from stockholders. The cash flow statement also tells the reader how much money was spent for items that do not appear on the income statement, such as loan repayments, long-term asset purchases, and payment of cash dividends.
DEVELOPMENT OF THE REPORTING STANDARD
In November 1987, the Financial Accounting Standards Board (FASB) adopted Statement of Financial Accounting Standards No. 95-Statement of Cash Flows. FASB 95 requires that a full set of financial statements includes a cash flow statement as the fourth required financial statement (along with a balance sheet, income statement, and statement of retained earnings). This statement established standards for cash flow reporting, and superseded the Accounting Principles Board (APB) Opinion No. 19, Reporting Changes in Financial Position.
APB Opinion No. 19, adopted in March 1971, had permitted, but did not require, enterprises to report cash flow information in a statement of changes in financial position, also commonly known as a funds statement. There was no required format or universally accepted definitions for categories in the statement, however, and the term “funds” itself was not sufficiently defined. Hence, the statement referred to changes in funds, but what constituted those funds differed across companies. Among the ambiguities, some firms defined funds as cash, some used cash and short-term investments, some used quick assets, and some used working capital.
While it was widely recognized that the funds statement payday loans same day Tennessee provided valuable and relevant information, the lack of consistency in format and focus from one firm to another was part of the reason that the FASB eventually took up the matter and, with extensive commentary from accountants and other interested parties, adopted the standards espoused in FASB 95. The standard, which took effect in 1988, discouraged use of the word “funds” in cash flow statements because the term had been cl6aked in so much ambiguity.
REQUIREMENTS FOR CASH FLOW STATEMENTS
FASB 95 requires that a statement of cash flows classify cash receipts and payments according to whether they stem from operating, investing, or financing activities. It also provides that the statement of cash flows may be prepared under either the direct or indirect method, and provides examples of how to prepare statements using each method.
Under the FASB standard, the core concept, cash, is defined as “cash and cash equivalents.” Cash includes currency and bank deposits, whereas cash equivalents include other highly liquid investments like U.S. Treasury bills, money market accounts, and commercial paper. Other sorts of investments such as stocks, bonds, futures contracts, and so forth are not considered cash.
CLASSIFICATIONS OF CASH RECEIPTS AND PAYMENTS
Nearly all business transactions completed during the fiscal year impact cash flow in one way or another, and in summary form they are factored into the year’s cash flow statement. Exactly where on the statement depends on the nature of the transaction. As noted, the three essential categories of cash flow are operating activities, investing activities, and financing activities. The components of each of these will be addressed separately.