Definition of Cash Flow Statement

A cash flow statement is one of the primary financial statements that shows the inflow and outflow of cash for a company during a specific time period. This statement aims to clarify the sources and uses of cash, and helps evaluate the company's ability to generate cash and manage liquidity. It is considered complementary to the income statement and balance sheet, as it focuses on actual cash flows rather than accounting profits, providing a clearer view of the company's real cash position and its ability to meet obligations and invest in future growth.

Components of a Cash Flow Statement

The cash flow statement consists of three basic components:

1. Cash Flows from Operating Activities

Includes cash flows resulting from the company's core operations such as collections from customers, payments to suppliers, salaries, and taxes. This is considered the most important component as it reflects the company's ability to generate cash from its primary activities.

2. Cash Flows from Investing Activities

Includes flows related to buying and selling long-term assets such as equipment and buildings, investments in securities, and company loans to others. It shows how the company invests in its future growth.

3. Cash Flows from Financing Activities

Includes flows related to company financing such as issuing shares, borrowing from banks, loan repayments, and paying dividends to shareholders. It shows how the company finances its operations and investments.

Net Change in Cash = Sum of the Three Cash Flows

Importance of a Cash Flow Statement

The cash flow statement is considered one of the most important financial tools in the business world due to its vital role in evaluating financial performance and cash position of companies:

• Liquidity Assessment: Shows the company's ability to meet short-term obligations and face financial crises
• Earnings Quality Measurement: Reveals whether accounting profits are supported by real cash flows
• Future Forecasting: Helps predict future cash flows and financial planning
• Investment Evaluation: Shows how the company invests in growth and expansion
• Financing Monitoring: Reveals financing sources and capital management strategies
• Credit Decision Support: Helps banks and lenders evaluate the company's ability to repay
• Management Efficiency Analysis: Shows management effectiveness in converting profits to cash
• Inter-company Comparison: Provides a reliable basis for comparing cash performance between different companies
• Risk Management: Helps identify financial risks and develop strategies to deal with them
• Standards Compliance: Meets requirements of international and local accounting standards

Methods for Preparing a Cash Flow Statement

There are two main methods for preparing a cash flow statement, and the two methods differ in the methodology for calculating cash flows from operating activities:

1. Direct Method

Relies on tracking and recording actual cash flows from operating activities directly, showing cash receipts from customers and cash payments to suppliers, employees, and taxes in detail. This method requires precise analysis of all cash and bank accounts to extract flows according to their nature. Despite its clarity and logic, it is more complex and costly to implement, requiring advanced accounting systems to track cash in detail.

2. Indirect Method

Starts with net income from the income statement and adjusts it to reach net operating cash flow, by adding non-cash expenses such as depreciation, and adjusting changes in working capital such as receivables, inventory, and payables. This method is easier to implement and less costly, as it relies on data available in basic financial statements, and is most commonly used in practice due to its simplicity and clear connection between accounting profit and cash flow.

Steps for Preparing a Cash Flow Statement

Preparing a cash flow statement is a precise and systematic accounting process that requires deep understanding of the nature of financial operations and correct classification of cash flows. This process begins with gathering data from various sources and ends with an integrated financial statement that reflects the company's actual cash movement. The accountant must follow adopted accounting standards and ensure accurate classification for each type of cash flow. The process also requires coordination with other financial statements to ensure consistency and coherence in financial data. The steps for preparing a cash flow statement include:

1. Basic Data Collection: Gathering balance sheets for current and previous periods and the income statement
2. Method Selection: Determining whether to use direct or indirect method for calculating operating flows
3. Calculating Operating Flows: Determining cash collected from customers and paid to suppliers, employees, and taxes
4. Identifying Investment Flows: Tracking purchases and sales of fixed assets and investments
5. Calculating Financing Flows: Recording borrowing and repayment operations, share issuance, and dividend distribution
6. Calculating Net Change: Summing net flows from the three activities to get total change in cash
7. Reconciliation with Balance Sheet: Ensuring calculated change matches the cash difference between the two balance sheets
8. Review and Classification: Examining classification accuracy and ensuring no duplication or omission of operations
9. Formatting and Presentation: Arranging the statement professionally with headings and subtotals
10. Final Approval: Reviewing the final statement and obtaining approval from competent management