The purpose of the statement of cash flows is to report a firm's cash inflows and outflows, during a period of time, segregated into three categories: operating, investing, and financing activities. This statement is required under Statement of Financial Accounting Standard (SFAS). When used with the information contained in the other two basic financial statements and their related disclosures, it should help the financial manager to assess and identify
• a company's ability to generate future net cash inflows from operations to pay debts, interest, and dividends
• a company's need for external financing
• the reasons for differences between net income and net cash flow from operating activities
• the effects of cash and noncash investing and financing transactions.
The statement of cash flows explains changes in cash (and cash equivalents, such as Treasur bills) by listing the activities that increased cash and those that decreased cash. Each activity - cash inflow or outflow is segregated according to one of three broad category types: operating, investing, or financing activity. Lists the activities found most often in a tvpic; statement of cash flows grouped according to the three required major categories.
The cash flow statement may be presented using either a "direct method" (which is encouraged by the Financial Accounting Standards Board because it is easier to understand) or ar "indirect method" (which is likely to be the method followed by a good majority of firirbecause it is easier to prepare). Making use of both methods, alternative cash flow statements for the Aldine Manufacturing Company are presented. (In addition, we shar with you a worksheet that we used to determine some of the operating activit cash flows required under the direct method. Hopefully, this will help remove any confusion concerning where those particular cash-flow figures originated.)
The only difference between the direct and indirect methods of presentation concerns the reporting of operating activities; the investing and financing activity sections would be identical under either method. Under the direct method, operating cash flows are reported (directly) by major classes of operating cash receipts (from customers) and payments (to suppliers and employees). A separate (indirect) reconciliation of net income to net cash flow from operating activities must be provided. (For the Aldine Company, this reconciliation appears in Table 7.5 as the last section of the statement of cash flows in Frame A.) This reconciliation starts with reported net income and adjusts this figure for noncash income statement items and related changes in balance sheet items to determine cash provided by operating activities.
Do the figures used in the reconciliation in Frame look familiar? They should. They consist of the firm's "funds provided by operations" plus all of Aldine's balance sheet changes in current assets and current liabilities except for the changes in cash and bar loans. All of these figures can be found on the finalized sources and uses statement for Aldine Table 7.3. The need for the figures used in the reconciliation provides another reason why cannot simply forget about the "replaced" sources and uses statement.
Under the indirect method shown in Frame B of Table 7.5, the reconciliation of net inconv, to net cash flow from operating activities moves up to replace the direct method's operating activity cash-flow section. In effect, then, the indirect method is just a reduced version of the direct method of presentation.