The statement of cash flows essentially tells you about cash entering and leaving a business. It’s arguably the most misunderstood and underappreciated part of a company’s annual report. After all, a business that reports positive net income on its income statements sometimes doesn’t have enough cash in the bank to pay its bills. Reviewing the statement of cash flows can provide significant insight into a company’s financial health and long-term viability.

Under Generally Accepted Accounting Principles (GAAP), the statement of cash flows is typically organized into three sections:

1. Cash flows from operations. This section focuses on cash flows from selling products and services. It customarily starts with accrual-basis net income. Then it’s adjusted for items related to normal business operations, such as:

• Gains or losses on asset sales,
• Depreciation and amortization,
• Income taxes, and
• Net changes in working capital accounts (such as accounts receivable, inventory, prepaid assets, accrued expenses and payables).

The end result is cash-basis net income. Companies that report several successive years of negative operating cash flows may be better off closing than continuing to incur losses.

2. Cash flows from investing activities. If a company buys or sells property, equipment or marketable securities, the transaction generally shows up here. This section reveals whether a company is reinvesting in its future operations — or divesting assets for emergency funds.
3. Cash flows from financing activities. This section shows cash flows from raising, borrowing and repaying capital. It highlights the company’s ability to obtain cash from lenders and investors, including:

• New loan proceeds,
• Principal repayments,
• Dividends paid,
• Issuances of securities or bonds, and
• Additional capital contributions by owners.

Capital leases and noncash transactions are reported in a separate schedule at the bottom of the statement of cash flows or in a narrative footnote disclosure. For example, if a borrower purchases equipment directly using loan proceeds, the transaction would typically appear at the bottom of the statement, rather than as a cash outflow from investing activities and an inflow from financing activities.

In addition, U.S. companies that enter into foreign currency transactions customarily report the effect of exchange rate changes as a separate item in the reconciliation of beginning and ending balances of cash and cash equivalents.

If you need to discuss your year end audit needs and benefits, please contact Mike Coglianese at 630-461-5841 or email Mike@cogcpa.com.