Net change in cash and cash equivalents

Putting it all together: The statement of cash flows

The cash flows from operating, investing, and financing activities are all combined in one statement of cash flows. The subtotals of the three activities combine into a single sum, referred to as the “net change in cash, cash equivalents, and restricted cash”.

The net change in cash, cash equivalents, and restricted cash is then added to the beginning balance of the same combined total to arrive at the ending balance. Under US GAAP (ASU 2016-18), this ending balance should agree to the corresponding amount disclosed in the statement of financial position, and any effect of exchange-rate changes on cash is shown as a separate reconciling line.

Example: Reconciling the net change in cash

Operating activities provide $40,000, investing activities use $25,000, and financing activities use $5,000. The beginning balance of cash, cash equivalents, and restricted cash is $30,000.

Net change: $40,000 − $25,000 − $5,000 = $10,000
Ending balance: $30,000 + $10,000 = $40,000

Answer: $40,000, which must agree with the combined cash, cash-equivalent, and restricted-cash amounts on the balance sheet.

As you may have already noted, the statement of cash flows can be derived from movements of balance sheet accounts: changes in current operating assets and liabilities (and net income adjustments) map to operating activities, changes in noncurrent assets map to investing activities, and changes in noncurrent liabilities and equity map to financing activities. The general treatments are summarized below:

See below combined statement of cash flows using the indirect method for the operating activities:

Pitfall: net income and operating cash flow diverge because net income is accrual-based while cash flow tracks actual cash; non-cash charges like depreciation are added back, and a rise in receivables ties up cash despite boosting revenue. Example: $50,000 net income + $15,000 depreciation − $70,000 increase in receivables = −$5,000 operating cash flow - negative despite positive net income.

Purpose and limitations of the statement of cash flows

The following a some of the purposes of the statement of cash flows:

• Cash flow information helps assess the company’s financial flexibility and risk
• It helps assess the company’s liquidity, which is the ability of the company to generate cash flows to service their obligations when they become due. However, this may lead to some limitations (see below)
• It helps users understand the prospects for future cash flows of the company
• Since the income statement is prepared using the accrual method, the statement of cash flows can help explain the difference between the cash flows and the company’s net income

The following are some limitations of the cash flow statement:

• It is not a measure of profitability, because it reports cash movements rather than accrual-based earnings
• Significant non-cash investing and financing activities (e.g., acquiring equipment by issuing a note) do not appear in the body of the statement; ASC 230 requires them to be disclosed separately
• The cash flow statement may not provide the full context of the company’s liquidity since payments can be delayed to show positive net inflows during the period. This is why the statement of cash flows should be analyzed in the context of other financial information
• The statement of cash flows may be complicated to prepare for consolidated financial statements with several entities