The statement of cash flows highlights the sources and uses of cash. It is arguably the most misunderstood and underappreciated part of a company’s annual report. Here is an overview of how this statement is organized and what the Financial Accounting Standards Board (FASB) has recently done to make it more user-friendly.
Cash flows from operations
The first section of the statement of cash flows adjusts accrual-basis net income for items related to normal business operations, such as gains, losses, depreciation, taxes, and net changes in working capital accounts. The end result is cash-basis net income.
Cash flows from investing activities
If a company buys or sells property, equipment, or marketable securities, the transaction generally shows up here. This section reveals whether a company is reinvesting in its future operations or divesting assets for emergency funds.
Cash flows from financing activities
The final section shows the company’s ability to obtain cash from lenders and investors. It includes new loan proceeds, principal repayments, dividends paid, issuances of securities or bonds, and additional capital contributions by owners.
The FASB recently issued Accounting Standards Update No. 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments, to reduce diversity in practice. The updated guidance clarifies that:
- Debt prepayment and extinguishment costs are classified as financing outflows
- Accreted interest related to zero-coupon debt instruments are generally classified as operating outflows; the principal portion is a financing outflow
- Contingent payments from a business combination are classified as investing outflows if paid soon after the acquisition date; later contingent payments are classified as financing outflows, and any payment over the liability is classified as an operating outflow
The guidance also prescribes how to report certain insurance proceeds and payments, distributions from equity method investees, beneficial interests in securitization transactions, and cash flows that qualify under more than one classification. For public companies, the changes are effective for years beginning after December 15, 2017, and interim periods within those years. Private companies have an extra year to comply.
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The statement of cash flows provides valuable insight about financial health and potential weaknesses, but it is not always clear how to classify transactions. We can help you get it right.