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The Statement of Cash Flows: Purpose, Format & Examples

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Lesson Transcript
Instructor: Rebekiah Hill

Rebekiah has taught college accounting and has a master's in both management and business.

There are four financial reports that are required in financial statements. In this lesson, you will learn about the fourth and final report - the statement of cash flows. You'll learn what the makeup of the statement is, its purpose, and why it is important to users of the financial statements.

Introducing the Statement of Cash Flows

The Financial Statements are the most sought after band in all of accounting. With just four members in the group, they each have specific purposes. In this lesson, we are going to take a look at the statement of cash flows, or SoFly for short, who is the group member that is responsible for explaining any changes in the cash balance of a company during an accounting period.

What Makes Up the Statement of Cash Flows?

People interested in accounting and fans of the Financial Statements needed something that would help them understand exactly what causes net income to change for a company. Out of this need, SoFly became the fourth member of the Financial Statements.

SoFly uses three specific types of activities to help him do his job. The first of those activities are called operating activities. These are the types of activities that occur during the normal day-to-day operations of a company. Each activity that occurs either affects cash coming into the company, called cash inflow, or cash leaving the company, called cash outflow.

For example, when a fan purchases concert tickets to see the Financial Statements perform, that is a cash inflow for the group. When the band pays their security team for providing security at their concerts, that is a cash outflow. Both of these activities are operating activities because they occur during the normal operations of the band.

The second type of activities that helps SoFly accomplish his job are investing activities. Investing activities are those accounting activities that involve buying or selling of long-term assets, as well as making or giving loans. Just as with operating activities, investing activities also have an effect on cash inflow and cash outflow. Let's look at some investing activities of the Financial Statements band as examples.

The band decided that its current tour bus is just too small for them, so they decide to sell it. The band sells the bus for $10,000. The money received from the sale of the bus is a cash inflow. It falls under the investing activities section of the statement of cash flows because the bus is considered a business asset. Once the old tour bus has been sold, the band invests in a newer, more modern bus. The purchase of the new bus is a cash outflow. It is a cash outflow under the investing activities because the new bus is a business asset for the band.

The third and final type of activities that helps SoFly perform his job are financing activities. Financing activities are accounting activities that involve cash receipts or cash payments from changes on long-term liabilities. Falling right into line with the other two types of activities that are part of the statement of cash flows, financing activities also have an effect on cash inflow and cash outflow.

The Financial Statements band has decided that it's time to branch out into further areas of business. They purchase a t-shirt shop that will make souvenir t-shirts that the band can sell at each concert. In order to purchase this shop, the band borrows money from the bank. The money borrowed from the bank is considered a cash inflow. The money paid out to purchase the shop is a cash outflow. Both of these actions are classified as financing activities because they involved the band incurring a bank loan, which is considered a notes payable in the accounting world.

Why Is the Statement of Cash Flows Important?

Now that you know what SoFly uses to assist him in performing his job with the band, let's look at why his job is important. Fans of the Financial Statements rely heavily on the group as a whole to paint a picture of how financially stable a company is. Each member of the band plays a specific role in painting that picture. The income statement and the statement of cash flow work closely together.

Some say that SoFly is really just an extension of Issy, the income statement. Why would that be? Well, simply put, Issy is responsible for telling fans the net profit or loss of a company during a given accounting period. SoFly goes beyond that by explaining why changes in cash balances occurred. That is the first of five reasons that SoFly is important to fans of the Financial Statements.

The second reason that SoFly is important to fans is because he helps them judge whether or not a company can pay the people that they owe money to. A third reason that SoFly is important to fans is because he helps them see whether or not a company has to borrow money to meet its debt obligations.

A fourth reason that SoFly is important to fans is because he helps them see why there are any differences between a company's net income and the actual cash receipts and cash payments that a company made during a specific accounting period. Net income is the excess of cash that has been received after deducting cash that has been paid out.

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