Statement of Cash Flows Theory

The Federal Accounting Standards Board (FASB) creates generally accepted accounting principles (GAAP) within the United States. The FASB is a non-governmental, not-for-profit organization created to establish financial accounting and reporting standards, for the private-sector. Although the Securities and Exchange Commission (SEC) legally controls this function for public companies, as part of its mandate to administer and uphold federal securities laws provisions, it has relied on the FASB since 1973 to fulfill this role (Walker, 2004). Of the 159 pronouncements made by the FASB, Statement 95 was issued in November 1987 and focuses on Statement of Cash Flows. The term 'cash flow', in general, refers to the movement of money in and out of a business, with cash inflow typically being correlated to sales and other receipts and outflow attributed to cash payments to others such as suppliers or workers, or more simply – the receipts and payments that are made by an organization (cited in Alver, 2005). In general, an organization's cash flow statement gives record to incoming and outgoing moneys, during a specific period of time. SFAS 95 establishes the standards for the reporting of cash flows, and sets the requiremen

However, Statement 95 is not written in stone. When using the direct method, a reconciliation of net income and net cash flow from operating activities is provided in a separate schedule ("Summary of statement", 1987). In addition, an understanding of the relation between the net cash flows from operating, investing and financing activities is necessary as well (Alver, 2005). To interpret a statement of cash flows, one must understand the relation between profit, in the form of net profit or operating profit, and cash flows from operation. This contrary treatment for dividends paid refers to the fact that dividends paid do not appear in the accrual income statement, as opposed to dividends and interest received and interest paid do appear in the accrual income statement. Statement 95 states that cash receipts and payments must be classified according to where they stem from, if their source is operating activities, investing activities and financing activities. Also included are interest revenue and expense stemming from non-operating activities. These activities are the major profit-directed activities undertaken by an organization (Alver, 2005). It clearly appears from the direct method of preparing CFS (cash flows statement)" (Alver, 2005). The operating section includes the organization's primary operations' revenue and expenses. These include: revenue, cost of goods or services, selling expenses, general and administrative expenses, and other operating expenses. Interest payments can have a significant effect on cash flow statements. These operating activities and the inflow and outflow of cash determine net profit or net operating profit. Investment returns and interest payments are thus separated from the sources of these activities, as well as the purchase and sale of investments that have been disclosed as investing activities, and the sale and retirement of debt that are disclosed as financing activities.