Besides the Income Statement and the Balance Sheet, there is a third financial statement called the Cash Flow Statement. The Cash Flow Statement reconciles the Income Statement with the actual cash position of the company (the balance in the bank account) by adding and subtracting revenues and expenses that were properly recorded on the Income Statement, but are non-cash events.
By non-cash events I mean expenses that have been properly associated with transactions or obligations but where no cash has yet changed hands. Depreciation, Amortization, and changes in Accounts Receivable and Accounts Payable are examples of non-cash events.
These additions and subtractions are reported in the Operations section of the Cash Flow Statement since they are related to the operations of the company that are reported on the Income Statement.
The need for a Cash Flow Statement arises from Accrual Accounting where we book items like Receivables and Payables and Depreciation in order to provide a more accurate picture of the operations of a company by matching revenues and expenses. These “non-cash” transactions distort the Income Statement relative to how much cash actually came in and went out of the company and how much is actually in the bank. The Operations portion of the Cash Flow Statement reconciles these differences.
Besides Operations, there are two other parts of the Cash Flow Statement that follow the Operations portion: Investing and Financing. The Investing section shows the money that was spent on capital equipment items that don’t show up as expenses on the Income Statement because they have been capitalized as Assets. It also shows any money that came into the company from the sale of assets.
The Financing section shows money that has come into the company through the sale of stock or the proceeds of a loan. It also shows any money that went out of the company from stock repurchases or loan repayments.
This reconciled cash balance is the number that then is added the previous Cash account balance reported at the top of the asset column on the Balance Sheet. This is important. This is how the financial statements are interconnected and reconciled.
The Cash Flow Statement is not as intuitive as the Balance Sheet and Income Statement. It will take you some time to wrap your head around it. Don’t run screaming if this concept isn’t crystal clear yet; just understand that the Cash Flow Statement is the connective tissue between the Balance Sheet and Income Statement.
The concepts behind the Cash Flow Statement are relatively nuanced and may seem a bit confusing to someone familiarizing themselves with the basic principles of accounting for the first time. As you read and work with financial statements, the different aspects of the Cash Flow Statement will become clear.
Sample Cash Flow Statement
Below is an example of a simple Cash Flow Statement. Since they vary in their contents and presentation it is a good idea to take a quick look at a bunch of examples. Google the term “Cash Flow Statement” and you will see lots of examples in various formats and presentations.
Statement of Cash Flows
For the Year Ended
December 31, 2015
(In Millions of Dollars)
Net Income from Operations $10,000
Add: Depreciation Expense 100
Total Operating Activities $10,100
Purchase of Equipment $ (1,000)
Sale of Equipment 500
Total Investing Activities $ ( 500)
Increase in Long Term Debt $2,500
Issuance of Stock 5,000
Dividends Paid (3,000)
Total Financing Activities $4,500
Net Change in Cash Flow $14,100