The Purpose of the Statement of Cash Flows
Simply put, the statement of cash flows gives the user information about the cash receipts and cash payments of the business during the accounting period. Whereas cash sources come from many different origins, such as customer payments, loans, and sales of assets and equity, the ways a company uses cash most likely directly trace back to costs. For example, buying equipment, paying invoices, and payroll.
Don’t confuse costs with expenses. In the world of accrual accounting, they’re not the same. For example, if a company buys a fixed asset with cash, the price it pays or promises to pay for the fixed asset is a cost. Over the useful life of the asset, the company depreciates it.
Depreciation is the process of reclassifying the cost of buying the asset as an expense of doing business. In this process, the resource the company uses to purchase the fixed asset moves from the balance sheet (cost) to the income statement (expense).
Knowing how a company manages its cash is useful to the external users of the financial statement, who aren’t privy to the day-to-day operations of the business. In other words, the company may be reporting net income period after period, but it doesn’t necessarily mean the company is rolling in cash.
And if a company has cash flow problems, there’s a good possibility that the business won’t be able to give the external users what they want: a return on their investment.
Besides potential investors, potential lenders are highly interested in whether the company has cash management under control. Lenders want to make sure the company can pay back both the principal portion of any loan plus any interest the lender charges for use of the money.
As with the income statement, the statement of cash flows is for a certain period, such as the 12-month period ending December 31, 2013.
When you start your required tax classes, keep in mind that a statement of cash flows isn’t required when using the tax basis of accounting.
Accounting Glossary
accounting equation
The equation Assets = Liabilities + Equity, which demonstrates the two-sided nature of accounting and is useful for explaining the concept of double-entry accounting (or double-entry bookkeeping).
Accounting Glossary
accounting period
The time period for which financial information is being tracked in a business, such as monthly, quarterly, or annually.
Accounting Glossary
accounts receivable
An account that records the amounts that customers owe to a business.
Accounting Glossary
adjusting entry
A correction made to a bookkeeping account that adjusts for accounting errors or other necessary changes at the end of the accounting period.
Accounting Glossary
cash flows
Used to describe the source or sources of cash or how cash is used.
Accounting Glossary
Chart of Accounts
A list of all the accounts used by a business, including what types of transactions go into each account.
Accounting Glossary
debit
An accounting entry that increases an asset or expense account, and decreases a liability or income account.
Accounting Glossary
dividends
A portion of a company’s profits paid by share of common stock on a quarterly or annual basis.
Accounting Glossary
FASB
Financial Accounting Standards Board. FASB is the highest-ranking authority in the private (non-government) sector of the U.S. for making pronouncements on GAAP and for keeping accounting standards up-to-date.
Accounting Glossary
Federal Unemployment Tax
In the U.S., the fund that used to be known simply as Unemployment. Employers contribute to the fund, and states also collect taxes to fill their unemployment fund reserves. (The acronym FUTA means Federal Unemployment Tax Act.)
Accounting Glossary
fidelity bonds
A type of insurance — typically carried by employers for their employees — that helps guard against theft and reduce the risk of loss.
Accounting Glossary
FIFO
First-in, first-out. A method for costs of goods sold in which a business charges out product costs to cost of goods sold expense in the chronological order in which the goods were acquired.
Accounting Glossary
fungible
Describes a product that is interchangeable and virtually indistinguishable from another product.
Accounting Glossary
General Ledger
A summary of all of a business’s accounts and transactions.
Accounting Glossary
IASB
International Accounting Standards Board. The IASB (based in London) is the main authoritative accounting standards setter outside the U.S.
Accounting Glossary
Journals
The location in which bookkeepers keep records (in chronological order) of daily company transactions.
Accounting Glossary
LIFO
Last-in, first-out. A method for costs of goods sold that selects the last item you purchased first, and then works backward until you have the total cost for the total number of units sold during the period.
Accounting Glossary
LLP
Limited liability partnership. A legal structure that state laws offer to qualified professionals in which all the partners have limited liability.
Accounting Glossary
PC
Professional corporation. A legal structure that state laws offer to qualified professionals who otherwise would have to operate as an unlimited partnership liability.
Accounting Glossary
petty cash
A cash account that businesses keep on hand for unexpected expenses.
Accounting Glossary
revenue
Monies that are collected in the process of selling a company’s goods and services.
Accounting Glossary
salvage value
The amount that an asset is worth after it has been fully depreciated.
Accounting Glossary
statement of cash flows
A financial statement that summarizes a business’s cash inflows and outflows during an accounting period.
Accounting Glossary
transactions
Economic exchanges between a business or other entity and the parties with which the entity interacts and makes deals.
Accounting Glossary
worker’s compensation insurance
A type of insurance carried by employers that covers its employees in case they are injured on the job.
