The purpose of the statement of cash flows is to summarize cash inflows and outflows over a period of time. It is an important statement because it can be used to assess what type of activities generated (or used) much of the company’s cash during the year. The statement of cash flows reconciles net income to the net change in cash during the period and is organized in three sections: operating, investing, and financing.
- The operating section of the statement of cash flows shows revenue or expense items that do not provide or use cash in the current period. Examples include stock option compensation expense or depreciation expense for computer hardware that are expenses in the income statement but don’t use cash in the current period. The statement of cash flows also includes the changes in current assets and current liabilities from the beginning of the period to the end of the period. This results in information on cash flows from sales and payments necessary to earn the sales. For example, if accounts receivable decreased from $500,000 to $400,000 during the period of the statement, then a positive $100,000 would be included next to accounts receivable in the operating section, indicating that the company saw a net increase in cash of $100,000 due to collections of accounts receivables. For startups and early stage companies, the net cash used by operations is a key component of calculating your burn rate.
- The investing section displays cash outflows and inflows from purchases and sales of long term assets. For example, software development costs incurred in the current period that are capitalized would be a negative amount in the investing section of the statement of cash flows, as it displays a use of cash that is not expensed in the current income statement. Such costs would also have to be considered in calculating your burn rate.
- The financing section includes sources and uses of financing funds. For example, paying dividends would be a negative amount (use of cash) and funding from issuance of preferred stock would be a positive amount (proceeds) in the financing section.
The net change in each of the sections represents the total change in cash from the beginning of the period to the end. This amount is then summed with the cash balance at the beginning of the period to arrive at the cash balance at the end of the period.
For more information on how you can use your financial statements to more effectively manage your business, please contact your Aronson advisor or Danielle Meyer at 301.231.6200.
About the Author: Danielle Meyer is a manager in Aronson LLC’s Technology Industry Services Group, where she provides comprehensive audit and accounting services to a diverse group of companies operating in the high tech, biotechnology/life sciences, e-commerce and software sectors.