Basic Accounting:
The Importance of the Cash Flow Statement

Let's take a moment to catch our breath in the discussion of the cash flow statement, and look at all the information we've absorbed so far and the importance of the cash flow statement in fulfilling the financial picture for the state of a business.

The Statement of Cash Flows is the new kid on the block as a member of the Financial Statement set.  This wasn't a required piece of the financial statement set until 1988.  As a result, there are still some areas that need fine tuning; such as the format used to report the cash flows.

The Statement of Cash Flows is the final document prepared in the Financial Report set, and provides information that is a direct flow of information from the Income Statement, Owner Equity Statement and Balance Sheet; therefore, this report adds validity and accountability to the Financial Statements.

Analysts, investors, stockholders, potential investors and lenders use these reports in order to assess the financial health of a business.   Therefore, it is tremendously advantageous to use the standard method for generating the Statement of Cash Flows and provide the additional credibility to the financial information.

A sample Statement of Cash Flows was provided in the first article in this series.  The importance of this report and the ability to accurately read and analyze the information is invaluable to an accountant.  So, take the time to become familiar with this report, as well as the other 3 that complete the Financial Statement set.

There are 3 major categories for the information that is reported on the Statement of Cash Flows and they are operating activities, investing activities, and financing activities.  Between the three major areas, every aspect of a business' transactions is covered.  The resulting totals on this report are direct flows of financial information totals from the other 3 reports in the financial statement set.  The only variance in reporting is in the operating activity area, concerning the cash transactions.  A business may choose to use an indirect or direct method for reporting cash transactions.  If a business chooses to use the direct method, there must also be a schedule attached that is basically also the indirect method in order to reconcile the information given in the direct method.

When we read the Statement of Cash Flows there are some basic numbers that will help you to assess a business; they are:

  • Net earnings or profit and loss information

  • Depreciation expense

  • Changes in inventory

  • Changes in accounts receivable

  • Changes in accounts payable

  • Changes in the "net cash from financing activities" that doesn't reflect equipment or building additions.

A general knowledge and good grasp of these Financial Statements, especially the Statement of Cash Flows will provide volumes of information to the reader, and if you're a potential investor or lender, you cannot know enough about a business before placing your money or that of your depositors in the operations of that business.  As an accountant, general knowledge will not be enough, but it's a step in the right direction!

Information is for educational and informational purposes only and is not be interpreted as financial or legal advice. This does not represent a recommendation to buy, sell, or hold any security. Please consult your financial advisor.