However, preparers are often guilty of hasty, mechanical preparation, which ultimately leads to unnecessary errors that make the statement from thereon less useful.
If cash is king, don’t we http://paydayloansohio.net/cities/findlay owe the statement that tells its story a little more respect? If you agree, here are what we consider to be the top 10 errors on the statement of cash flows.
1. Misclassifying the three categories of cash flows
All cash flows originate at one of these three categories: operating, investing or financing. The most common error when preparing the cash flows is the improper categorization therein.
When in doubt, there are a few tips that can help you choose correctly. Remember that each category is generally associated with a financial statement “area” that they can be tracked back to, as noted below. Also remember that there is an exception to every rule ….
Investing activities are typically related to changes in long term assets: Common examples include purchasing fixed assets, certificates of deposits, marketable securities (What do we do with extra cash?).
Financing activities are typically related to changes in long term liabilities and/or equity: This includes notes payable and issuance of stock, all of which are sources of financing for the company’s needs (How do we get cash from outside the company?). This section also discloses changes in lines of credit (a short-term liability). This is an example of the exception to the rule.
Operating activities are typically related to the income statement and changes in current assets and current liabilities: This includes really almost everything else, such as any cash flows that are the result of operations, even if there is a financing or investing facet to them. For example, investing in inventory or financing via accounts payable are still operating activities (How well do we generate cash flows?).
This is also the area you should probably focus your time on in the financial review. Negative cash flows from operations might seem concerning, but maybe that is totally normal during certain periods and should be frightening at others. Tracking and analyzing is the best way to know.
2. Not applying the fourth category of cash-flows
The truth is that there is kind of a fourth category: non-cash transactions. This category is often missed and improperly included in the statement of cash flows as if cash changed hands.
A good example is dealer-provided financing. When purchasing a new vehicle via the issuance of a note payable, there is a tendency to show the gross purchase price and the new note balance in full within the investing and financing areas, respectively. Yet there was actually no cash that changed hands in this transaction. We simply signed a piece of paper.
If items are financed through a financial institution, as opposed to a dealer, it may be proper to account for the gross transaction, as the substance and form ple, the bank may have actually cut a check to the company. However, this is more commonly the exception than the rule.
3. Not disclosing non-cash transaction
Many things in life don’t make sense. Add to that list needing to disclose non-cash transactions on the statement of cash flows. The same way it is a common error to gross up investing and financing line items for non-cash transactions, it is an error to omit any mention of them. The form of presentation can vary, be it tabular or in a narrative at the bottom of the statement of cash flows. If there are several and/or complex non-cash transactions, a separate footnote might be a more viable option.
