Financial Statements Part 3: Cash Flow

The Cash Flow Statement or Sources & Uses of Cash is the third of the three primary financial reports (see the last two week’s solutions for an introduction to the Income Statement and Balance Sheet.)  In totally cash-based accounting, there is no difference between the Income and Cash Flow Statements because transactions are only recorded when cash is exchanged.  However, most companies operate at some level of accrual-based accounting so the Cash Flow Statement is required to report the difference between Net Income and the change in cash for each accounting period.  For this reason, many Cash Flow Statements begin with Net Income and then adjust it for timing differences to reach the change in Cash.


Accrual-based accounting recognizes transactions when they occur, whether or not cash has changed hands.  The timing differences created by transactions that will become cash in another accounting period are held in accounts on the Balance Sheet.  It follows, therefore, that the Cash account will change by the sum of changes in all of the other Balance Sheet accounts.  These calculated changes are represented in the sample report above.

Here are where the most common timing differences appear on the Balance Sheet:

  1. Sales invoiced but not paid / prior invoices paid in current period … Accounts Receivable
  2. Bills received but not paid / prior bills paid in current period … Accounts Payable
  3. Long term assets purchased … Fixed Assets
  4. Depreciation of long-term assets … Accumulated Depreciation
  5. Advance payments made … Prepaid Expense
  6. Expenses charged to credit cards / credit card payments made … Credit Card Payables
  7. Investment in the company … Equity

Sources and Uses of Cash is another presentation style of Cash Flow that groups the changes in the cash balance by its sources: Income, payment of open Accounts Receivable, borrowing, investments; and uses: pay bills, pay employees, buy equipment, pay loans.

To manage your expectations of cash requirements for your business, keep the following in mind:

  1. Increase in Assets – uses cash
  2. Decrease in Assets – generates cash
  3. Increase in Liabilities – generates cash
  4. Decrease in Liabilities – uses cash
  5. Increase in Equity – generates cash
  6. Decrease in Equity – uses cash

So the Cash Flow Statement rounds out the trio of primary Financial Statements.  Its importance to a business owner is to highlight the impact of timing differences on the amount of cash required to continue the operation.  In general, growing a business uses cash, while scaling down generates cash.

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