Decoding the Statement of Cash Flows for the FAR CPA Exam
Kyle Ashcraft, CPA · 2019 CPA Exam Scores · 95 FAR · 98 BEC · 91 REG · 90 AUD
The statement of cash flows tracks every dollar of cash moving in and out of a company during a period — and it's essential for understanding liquidity and solvency. It's a heavily tested statement on the FAR section of the CPA exam, from its three-part structure to the two ways of preparing it.
What are the three sections of the statement of cash flows?
Every statement of cash flows is organized into three sections:
- Operating activities — cash from core business operations
- Investing activities — cash from buying and selling long-term assets
- Financing activities — cash from transactions with owners and creditors
Operating activities
Operating activities cover the cash effects of running the core business — cash received from customers and cash paid to suppliers and employees.
Example: cash received from customers
- Debit Cash $50,000
- Credit Accounts Receivable $50,000
Example: payment to suppliers
- Debit Accounts Payable $30,000
- Credit Cash $30,000
Investing activities
Investing activities cover the purchase and sale of long-term assets, like property, plant, and equipment (PP&E) and investments — a window into a company's long-term strategy.
Example: purchase of equipment
- Debit PP&E $20,000
- Credit Cash $20,000
Financing activities
Financing activities cover transactions with a company's owners and creditors — issuing stock, borrowing money, and repaying debt.
Example: issuance of stock
- Debit Cash $10,000
- Credit Common Stock $10,000
What's the difference between the direct and indirect method?
U.S. GAAP allows either method for presenting cash flows from operating activities — the choice never affects investing or financing activities.
Direct method: lists the major operating cash receipts and payments directly — cash received from customers, cash paid to suppliers.
Indirect method: starts with net income and adjusts for changes in balance sheet accounts to arrive at cash from operations — adding back depreciation and adjusting for changes in working capital.
Worked example: the indirect method
Say a company reports:
- Net income: $40,000
- Depreciation: $10,000
- Increase in accounts receivable: $5,000
- Increase in accounts payable: $3,000
Net income is adjusted upward for the non-cash depreciation expense, downward for the AR increase (revenue recognized but not yet collected), and upward for the AP increase (expense recognized but not yet paid).
Why does this statement matter?
- Liquidity — can the company cover its short-term obligations?
- Solvency — can the company meet its long-term debts?
- Internal financing — how much cash is the business generating on its own, without external funding?
The statement of cash flows reconciles accrual-basis net income back to actual cash. On the exam, expect questions that ask you to classify a transaction into one of the three sections, or to compute cash from operations under the indirect method.
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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.
