The statement of cash flows often gets a bad rap due to the complexity of its preparation. However, it is my hope that once you understand what activity goes into each section, and how to set-up a good template for deriving the numbers, you will no longer feel the same dread before preparing the document.
This article focuses on preparing the indirect method of reporting the statement of cash flows. The indirect method reconciles the change in net assets to the net cash flows from operations, starting with the accrual basis change in net assets, and then backs out the impact of all accruals and noncash items.
Purpose of Statement of Cash Flows
958-230-05 of the FASB Codification notes that the “primary purpose of the statement of cash flows is to provide relevant information about the cash receipts and cash payments of an entity during a period.”
This information is useful to the users of the financial statements, including management. It offers them a picture into the sources of cash that are being used to fund the organization. For instance, is cash from operations negative, requiring the organization to take out a line of credit or loan to fund operations? Alternatively, some organizations rely on investments to generate investment income from interest and dividends to fund operations.
Primary Sections of the Statement of Cash Flows
The statement of cash flows is separated into three primary sections, as defined by ASC 230-10-05:
“Operating activities include all transactions and other events that are not defined as investing or financing activities. Operating activities generally involve producing and delivering goods and providing services. Cash flows from operating activities are generally the cash effects of transactions and other events that enter into the determination of net income.”
“Investing activities include making and collecting loans and acquiring and disposing of debt or equity instruments and property, plant, and equipment and other productive assets, that is, assets held for or used in the production of goods or services by the entity (other than materials that are part of the entity’s inventory). Investing activities exclude acquiring and disposing of certain loans or other debt or equity instruments that are acquired specifically for resale.”
“Financing activities include obtaining resources from owners and providing them with a return on, and a return of, their investment; receiving restricted resources that by donor stipulation must be used for long-term purposes; borrowing money and repaying amounts borrowed, or otherwise settling the obligation; and obtaining and paying for other resources obtained from creditors on long-term credit.”
Commons Items Reported in Each Section
Operating includes adjustments for non-cash items such as depreciation, gains and losses on investments, gains and losses on the sale or disposal of fixed assets, amortization of loan fees or intangible assets, and goodwill or other long-lived asset impairment. In addition, contributions restricted for long term purposes such as capital projects or endowment contributions are also removed from the operating section.
Next, the cash changes from the statement of financial position assets and liabilities, with the exception of those included in investing and financing activities sections, are presented.
Examples of assets included in the operating section: accounts receivable, inventory, prepaid asset, and other current assets.
Examples of liabilities included in the operating section: accounts payable, accrued liabilities, deferred revenue, and other current liabilities.
This section includes purchases and sales of investments, purchases and sales of fixed assets, issuance of notes receivable and collections on notes receivable, and cash receipts from insurance settlement proceeds related to fixed assets.
Financing includes proceeds from debt and payments on debt, cash payments of debt issuance costs, cash collections on contributions or grants restricted for long-term assets, and draws and payments on a line of credit.
Other Sections in the Statement of Cash Flows
Reconciliation to Cash
All statements of cash flows include the beginning balance of cash, the change in cash, and the yearend balance that agrees to the cash balance on the statement of financial position. All types of cash and cash equivalents (cash, restricted cash, designated cash, short term investments with maturities of three months or less, etc.) that are presented on the statement of financial position flow through the statement of cash flows and are included in the beginning and ending cash balance. As a result, organizations must present and sum the various types of cash on the statement of cash flows to reconcile to the total change in cash. An organization may also elect to include this information in notes to the financial statements.
This section will provide further information on non-cash activities such as fixed asset purchases included in accounts payable at year end, cash paid for interest, income taxes paid during the period, and purchasing fixed assets with finance leases.
Gross versus Net Cash Flow Reporting
Generally, as with the statement of activities, netting of activity is not suggested or permitted. However, there are certain items with quick turnover that are allowed to be netted on the statement of cash flows. These include assets or liabilities with an original maturity of three months or less, including investments, loans receivable, and debt. Amounts that are due on demand, such as a revolving line of credit, may also be reported net.
Proceeds from the Settlement of Insurance Claims
The proceeds are recorded in the operating section unless the settlement relates to a fixed asset and would appear in investing activities.
Not-for-Profit Specific Nuances
Contributions Restricted for Long Term Assets, Including Endowments
When preparing the statement of cash flows on the in-direct method, revenue recognized from these types of donations is backed out of the non-cash operating section. Any amounts received on current contributions or payments on prior period pledges are reported in the financing section. Any current year contributions that are pledges and not yet received are adjusted through the change in the pledge receivable balance in the operating section.
Some organizations may hold assets on behalf of other entities. In these circumstances, any changes in the related asset and liability appear in the operating section of the statement of cash flows. When an organization utilizes the indirect method to prepare the statement of cash flows, the organization is allowed to report these cash inflows and outflows as gross or net.
Cash flows from activity related to art and other similar collections are recorded as investing activities.
Tips for Creating a Template to Accumulate the Necessary Numbers for a Statement of Cash Flows
Now that you know what information belongs in each section of the statement of cash flows, the following template will help you gather the numbers that will be disclosed in the statement:
First, create a statement of cash flows rollforward for significant areas such as investments, debt, pledges, and fixed assets. This additional information will allow you to clearly break out the cash and non-cash changes in these balances.
If preparing the statement of cash flows as a result of a financial statement audit, add these cash flow rollforwards to the supporting schedules for these sections.
Finally, for all other assets and liabilities that appear in the operating section of the statement of activities, utilize the organization’s two-year presentation of the statement of financial position to calculate the year over year change to populate the operating section of the statement of cash flows.
Armed with these definitions, nuances, and tips, I hope you are no longer intimidated by the thought of preparing the statement of cash flows using the indirect method. If you have any questions on preparing the statement of cash flows, please send me an email.
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