Understanding Cash Flow Statements
Kyle Ashcraft, CPA · 2019 CPA Exam Scores · 95 FAR · 98 BEC · 91 REG · 90 AUD
A company can be profitable on paper and still run out of cash. The statement of cash flows exists to show what actually happened to cash during the year, separate from net income.
What are the three sections of the cash flow statement?
Every transaction that affects cash falls into one of three buckets:
- Operating Activities — the company's core business
- Investing Activities — buying and selling long-term assets
- Financing Activities — raising or repaying capital
How does the indirect method work?
The indirect method — the version tested almost exclusively on FAR — starts with net income and reverses out anything that isn't actually cash. Depreciation is the classic example: it reduces net income, but no cash changes hands, so it gets added back.
What counts as investing activities?
Investing activities cover cash spent on or received from long-term assets — most commonly the purchase and sale of fixed assets. Both the original purchase and any later sale of that same asset stay in this section.
What counts as financing activities?
Financing activities cover how the company raises or returns capital: taking out a loan, issuing equity, and paying dividends all land here.
Worked example: selling a fixed asset
A company sells a piece of machinery for $45,000 cash on September 15, Year 3. The machinery was purchased in Year 1 for $60,000 and had accumulated depreciation of $25,000 by the sale date.
Gain on sale = $45,000 − $35,000 = $10,000
The journal entry to record the sale:
| Account | Debit | Credit |
|---|---|---|
| Cash | $45,000 | — |
| Accumulated Depreciation | $25,000 | — |
| Machinery | — | $60,000 |
| Gain on Sale | — | $10,000 |
The full $45,000 goes to Investing Activities as a cash inflow. But that $10,000 gain also boosted net income up in Operating Activities. Leave it there, and the gain gets counted twice. So it's subtracted back out of net income in the Operating section — the only place the gain shows up is the one place the actual cash showed up: Investing.
Cash flow cheat sheet
| Section | Typical items |
|---|---|
| Operating | Net income; add back depreciation/amortization; subtract gains, add back losses on asset sales; changes in working capital accounts (AR, AP, inventory, accrued liabilities) |
| Investing | Purchase or sale of fixed assets; purchase or sale of investment securities; loans made to other entities |
| Financing | Issuing or repaying debt; issuing stock; buying treasury stock; paying dividends |
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Kyle Ashcraft, CPA scored 90 or above on every section of the CPA exam in 2019, including a 95 on FAR. He is the founder and sole instructor of Maxwell CPA Review, a complete CPA review course covering all six sections, where he creates every lecture, textbook and study outline himself.