Statement of cash flows

The statement of cash flows shows how a company generated and used cash during a reporting period. While the income statement is prepared on an accrual basis — recording revenue when earned and expenses when incurred — the cash flow statement strips accruals away and tracks actual cash movement, which is why a profitable company can still run out of cash.

Every cash flow is classified into one of three sections. Operating activities cover the core business: cash collected from customers and cash paid to suppliers and employees. Investing activities include buying and selling long-term assets such as equipment, buildings, and investment securities. Financing activities capture transactions with owners and lenders — issuing or repurchasing stock, borrowing, repaying debt, and paying dividends. The three sections net together to explain the change in cash from the beginning to the end of the period.

The operating section can be presented two ways. The direct method lists actual cash receipts and payments, while the far more common indirect method starts with net income and adjusts for non-cash items (like depreciation) and changes in working capital accounts (like receivables, inventory, and payables). Both methods produce the same operating cash flow total.

The statement of cash flows is tested on both the CMA Part 1 exam and the ACCA Financial Accounting (FA) exam. Candidates should be able to classify transactions into the three activity sections, prepare the operating section under the indirect method, and reconcile net income to cash provided by operations.