The Six-Step Process for Preparing a Statement of Cash Flows - Lesson | Study.com (2024)

The next step is to start with net income and add depreciation back in, since it was a deducted non-cash transaction on the income statement. Now we'll account for incoming and outgoing operating cash activities. Operating activities are the actions the business undertakes as a normal course of doing business. Examples of the widget company's outgoing operational cash activities include: paying suppliers, rent, utilities, and taxes. After this, we can add any incoming operational cash activities, such as customers paying their widget credit accounts.

The CPA explains the next category is investing. Daniel chuckles and expresses the widget company barely pays its bills, let alone invests in the stock market. The CPA clarifies investing activities include buying and selling securities as well as property, plant, and equipment. For example, let's say you heard behind closed doors the city plans to develop hundreds of acres of land next to the widget business. If you had the money, you could purchase the land at a discount, which constitutes a decrease in cash. If the city purchased your land at a premium six months later, the new profit would be listed in this section as incoming cash due to investment.

Most businesses at some point take out loans to finance startup costs or buy equipment, buildings, vehicles, trucks, or inventory. Hence, financing activities involve borrowing cash. In the past, the widget business utilized two main types of financing: debt and equity. Debt financing consists of obtaining loans or selling bonds. Both require the borrower, the widget business, to pay regular periodic interest payments and the principal (the amount borrowed at maturity). These transactions are considered outgoing cash activities. Equity financing entails selling stock to the public and in return paying the stockholders dividends - another outgoing cash activity.

Daniels asks the CPA if there are any incoming cash activities in this section. The CPA smiles and answers, yes, when you receive the money you borrowed, either from the bank, bondholders, or stockholders. Daniel laughs and says, 'Oh, yes that's right!' The CPA offers Daniel the following reference card on incoming and outgoing activities by category:

Next is simply to calculate the differences between incoming and outgoing cash transactions. As previously noted in step 1, the widget company's net cash is a positive $5,000, which explains their financial health. It's important to note, startup or rebounding companies may have a net negative cash. However, a solid plan should explain steps to reach future positive cash flows. Here is what one looks like; pay attention to the items listed and where they go:

The last step is to notate disclosures such as non-cash activities (for example, which assets were depreciated and added back to operating activities). Daniel thanks the CPA and asks if he could construct the statement of cash flows for the last five years and provide an analysis. The CPA agrees and says he'll send an invoice for the work next week.

A statement of cash flows provides details on incoming and outgoing cash transactions and explains net increases or decreases in cash. The first step is to calculate the new cash balance by subtracting beginning cash from ending cash. The difference will become beginning cash for the following year. Steps two through four involve calculating the incoming and outgoing cash for operating, investing, and financing activities. Operating activities are the actions the business undertakes as a normal course of doing business. Investing activities include buying and selling securities as well as property, plant, and equipment. Financing activities involve borrowing cash from a bank, bondholders, or stockholders and repayment or dividends. Step five is to calculate net cash and, finally, in step six, we notate disclosures.