Understanding the Statement of Cash Flows

Dan Montgomery, CPA and Senior Assurance Associate at TDT, explains why having an effective internal control system is important. With more than ten years of experience, Dan specializes in audits of nonprofits, governmental entities, and employee benefit plans.

Required Financial Statements

Under Generally Accepted Accounting Principles (GAAP), there are three basic financial statements that nonprofits are required to report: (i) the Statement of Financial Position, (ii) the Statement of Activities, and (iii) the Statement of Cash Flows.

The Statement of Financial Position is another name for a balance sheet. It reports an organization’s assets, liabilities, and net assets at a specific point in time. The Statement of Activities is another name for a profit and loss statement. It reports an organization’s income and expenses for a specific period of time and reflects the changes to an organization’s net assets resulting from income and expenses that occur during the period reported.

Most people have an easy time grasping the two statements discussed in the preceding paragraph. However, the Statement of Cash Flows, which is the statement that links the Statement of Financial Position and Statement of Activities together, can be challenging to understand.

The Statement of Cash Flows

The Statement of Cash Flows is a financial statement that shows how changes in balance sheet accounts affect cash and cash equivalents and breaks the analysis down into three types of activities: (i) operating, (ii) investing, and (iii) financing. It’s natural for people to look at the Statement of Activities and say, “we turned a profit this year, but I don’t understand why my cash balance decreased.” This is where the Statement of Cash Flows comes in handy.

There are many transactions that do not flow through to the Statement of Activities. For example, property and equipment are recorded as assets and depreciate over time. The upfront cost of the property and equipment only flows through to the Statement of Activities in the form of depreciation expense. The Statement of Cash Flows adds back depreciation expenses and subtracts the full purchase price of the property and equipment in order to reconcile the change in cash.

Another common transaction is repayment of long-term debt. Principal payments of debt are not recorded on the Statement of Activities. Instead, they are recorded against the liability listed on the Statement of Financial Position. On the Statement of Cash Flows, principal payments of debt are subtracted from cash to account for the cash used to pay down debt balances.

Cash flows in the Statement of Cash Flows are divided into the following three areas:

  • Operating activities – These consist of the operating activities of the nonprofit. For instance, cash received and disbursed for programs, grants, payroll, and administrative costs, etc.
  • Investing activities – These consist of payments made to acquire long-term assets, as well as cash received from their sale. Examples of investing activities are the purchases of fixed assets and the purchase or sale of investments.
  • Financing activities – These consist of activities related to the acquisition or payment of debt.

In my view, the most important line on the Statement of Cash Flows is “net cash provided by operating activities.” This shows the cash that was generated or used by operating activities and provides an accurate picture of the amount of cash that was available to purchase property and equipment, fund reserve accounts, and make payments on long-term debt.

Concluding Thoughts:

The Statement of Financial Position and the Statement of Activities are important tools for evaluating an organization’s health; however, the Statement of Cash Flows is a necessary complement to these. This article provides just a glimpse into the Statement of Cash Flows. If you or your board of directors would like assistance in strengthening your financial fluency, please don’t hesitate to contact TDT; we are here to help you!

By |2018-07-13T11:00:15+00:00May 8th, 2018|Budget, Cash Flow, Nonprofit|

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