Statement of Cash Flows - General Structure
The statement of cash flows includes only the inflows and outflows of cash (and cash equivalents). Income statements and balance sheets are typically prepared on an accrual basis. On an accrual basis when a product is sold on 30 day terms, the sale is recognized at the time the products or services are provided. On a cash basis, the sale is not recognized until the cash is actually received. The statement of cash flows provides a bridge between these two accounting systems.
The statement of cash flows is typically divided into three sections:
Investing Activities (also called Discretionary)
Cash Flow from Operations
The indirect (reconciliation) method derives net cash from operating activities by adjusting net income for revenue and expense items not resulting from cash transactions. See Indirect Method.
The direct method determines cash flow from operations from operating cash receipts and payments as opposed to adjusting net income for items that do not impact cash. See Direct Method.
Cash Flow from Investing Activities (Discretionary Cash Flow)
Cash flow from investing activities is usually negative and reflects the acquisition of fixed assets and investments. These discretionary purchases may be funded through positive cash flow from operations, a reduction in cash or from financing activities (borrowings). Components of Investing activities include the purchase and sale of fixed assets (PP&E) and the acquisition and sale of investments.
Cash Flow from Financing Activities
The cash flow from financing activities section details repayment of principal and borrowings. Cash flow from operations should be sufficient to support the amortization of debt, a major component of financing activities. Components include short-term borrowings, changes in capital leases and borrowings and repayment of long-term debt. The impact of debt restructuring is summarized in this section.