The Conceptual Framework Underlying the Preparation of the Statement of Cash Flow

19 Pages Posted: 21 Oct 2008

See all articles by Luann J. Lynch

Luann J. Lynch

University of Virginia - Darden School of Business

Paul J. Simko

University of Virginia - Darden School of Business

Abstract

The objective of the statement of cash flow is to facilitate an understanding of the financial consequences of business activities by providing detail pertaining to the sources and uses of a company's cash. While the income statement and balance sheet are based on accrual accounting, the statement of cash flow is intended to represent the cash-flow consequences of business activities. Most of the challenge with preparing and ultimately understanding, the statement of cash flow is due to a failure to appreciate the relation between the statement of cash flow and other financial statements. The purpose of this note is to discuss the conceptual framework underlying the preparation of the statement of cash flow that is based on that relation.

Excerpt

UVA-C-2250

The Conceptual Framework Underlying

the Preparation of the Statement of Cash Flow

The objective of the statement of cash flow is to facilitate an understanding of the financial consequences of business activities by providing detail pertaining to the sources and uses of a company's cash. While the income statement and balance sheet are based on accrual accounting, the statement of cash flow is intended to represent the cash-flow consequences of business activities. Most of the challenge in preparing, and ultimately understanding, the statement of cash flow is due to a failure to appreciate the relation between the statement of cash flow and other financial statements. The purpose of this note is to discuss the conceptual framework underlying the preparation of the statement of cash flow that is based on that relation.

Overview

The statement of cash flow contains three sections: operating, investing, and financing, each of which present detail related to cash flow from these activities. Under U.S. GAAP (Generally Accepted Accounting Principles), there are two acceptable methods of presentation of the statement of cash flow: (1) the indirect method and (2) the direct method. The difference in these two methods lies only with the presentation of the operating-activities section of the statement. Specifically, the direct method directly lists cash receipts and disbursements related to operations to arrive at cash flow from operating activities (CFO); the indirect method begins with net income taken from the income statement, which is determined by using accrual accounting, and adjusts it for items that reflect differences in net income and actual operating cash flows. Both methods result in identical CFO amounts.

. . .

Keywords: financial accounting, statement of cash flow

Suggested Citation

Lynch, Luann J. and Simko, Paul, The Conceptual Framework Underlying the Preparation of the Statement of Cash Flow. Darden Case No. UVA-C-2250, Available at SSRN: https://ssrn.com/abstract=1276991

Luann J. Lynch (Contact Author)

University of Virginia - Darden School of Business ( email )

P.O. Box 6550
Charlottesville, VA 22906-6550
United States
434-924-4721 (Phone)
434-243-7677 (Fax)

HOME PAGE: http://www.darden.virginia.edu/faculty/lynch.htm

Paul Simko

University of Virginia - Darden School of Business ( email )

P.O. Box 6550
Charlottesville, VA 22906-6550
United States
434-924-1391 (Phone)

HOME PAGE: http://www.darden.virginia.edu/faculty/simko.htm

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