Statement of Cash Flows: A Simple Guide to the 3 Sections

The statement of cash flows is a financial statement that reports the cash a company received and paid during a period, grouped into three sections: operating, investing, and financing activities. Also called the cash flow statement, it explains why the cash balance changed, which net income alone cannot show.

This introductory guide follows U.S. generally accepted accounting principles (GAAP), the accounting rules used in the United States. The cash flow rules are in Accounting Standards Codification (ASC) Topic 230, maintained by the Financial Accounting Standards Board (FASB). A profitable company can still struggle to pay suppliers if customers have not paid their invoices.

Video: What is the statement of cash flows?

Watch Professor Farhat introduce the purpose of the statement and explain the three activity categories in this 15-minute lesson.

Watch this lesson on the Farhat Lectures YouTube channel.

Key takeaways

• The statement of cash flows reports cash received and cash paid during a period and explains the change in the cash balance.
• It has three sections: operating, investing, and financing activities.
• Under U.S. GAAP, interest paid, interest received, and dividends received are operating. Dividends paid are financing.
• Significant noncash investing and financing transactions, such as issuing shares for land, are disclosed separately and stay out of the cash totals.
• The direct and indirect methods differ only in how the operating section is presented. Both give the same operating cash flow.
• Beginning cash plus the net increase in cash, or minus the net decrease, equals ending cash.

Why the statement of cash flows matters

An income statement measures revenues and expenses using accrual accounting: recognition does not always occur when cash changes hands. A balance sheet reports financial position at one date. The cash flow statement connects beginning and ending cash through the activities that occurred between those dates.

For example, a service performed on credit increases revenue and accounts receivable. It creates no cash receipt until the customer pays. Conversely, borrowing increases cash even though it creates no revenue. These differences explain why looking only at profit or the change in cash can produce an incomplete assessment.

The guide to classified financial statements explains how the statements fit together. For this statement, focus on the source or use of cash rather than the current/noncurrent labels on the balance sheet.

What are the 3 sections of the statement of cash flows?

Under U.S. GAAP, ordinary interest paid, interest received, and dividends received are operating cash flows. Dividends paid are financing cash flows. Buying an investment differs from receiving income on that investment. Advanced exceptions and specialized industries are outside this introductory lesson.

This Securities and Exchange Commission (SEC) staff overview of the cash flow statement illustrates the three-section structure. Accounting Standards Codification (ASC) Topic 230 contains the U.S. GAAP requirements.

Ask who borrowed or lent the money

When your company borrows $20,000 from a bank, it receives financing cash. When your company lends $20,000 to another business, it uses investing cash. The same word, “loan,” describes different roles. Repayment of the principal follows the original category; ordinary interest is operating.

Statement of cash flows example: Harbor Design

Hypothetical example. Harbor Design begins 20X7 with $12,000 of cash. During the year it collects $90,000 from customers, pays $62,000 of operating costs, purchases equipment for $24,000 cash, borrows $18,000, and pays $5,000 in cash dividends. There are no other cash movements.

Parentheses indicate a cash outflow or decrease. Borrowing explains part of the increase in cash, so the $17,000 increase is not a measure of profit. The operating section here lists cash receipts and payments directly. That presentation is called the direct method. The section below shows the indirect method, which reaches the same $28,000 starting from net income.

Here is the same information in the layout you will see in real financial statements.

Direct method vs. indirect method: what is the difference?

The two methods only change how the operating section is presented. The investing and financing sections look the same either way, and both methods arrive at the same operating cash flow.

Direct method. You list the cash received and the cash paid for operations. The Harbor Design statement above does this: $90,000 collected from customers minus $62,000 paid for operating costs equals $28,000.

Indirect method. You start with net income, then adjust for items that changed profit but not cash, and for changes in operating accounts such as receivables and payables.

Hypothetical continuation. Suppose Harbor Design reports net income of $21,000 for 20X7. That profit is after $4,000 of depreciation, an expense that spreads the cost of equipment over its useful life and uses no cash. During the year, accounts receivable (amounts customers still owe Harbor) increased by $2,000, and accounts payable (amounts Harbor still owes its suppliers) increased by $5,000.

Why these adjustments? Depreciation reduced profit without using cash, so you add it back. Receivables went up because $2,000 of this year’s sales has not been collected yet, so you subtract it. Payables went up because Harbor has not yet paid $5,000 of this year’s costs, so you add it back.

Both methods give $28,000. Most companies present the indirect method. A company that presents the direct method must also provide the reconciliation from net income in a separate schedule.

For a full walkthrough, see the indirect method worked example.

Where do significant noncash transactions go?

Significant investing and financing transactions that use no cash are disclosed separately, rather than included as cash inflows and outflows in the body of the statement. Disclosure can appear in a supplemental schedule or financial statement notes. Examples include issuing shares for land, converting bonds into shares, or acquiring equipment by signing a note.

Hypothetical variation. Harbor also obtains a $16,000 machine by issuing a note directly to the seller. The machine and debt are recorded, but neither a $16,000 investing cash outflow nor a $16,000 financing cash inflow belongs in this year’s cash totals. The $29,000 ending cash remains unchanged. Describe the $16,000 equipment-for-note transaction in the noncash disclosure.

If a purchase includes a cash down payment and seller financing (the seller lets the buyer pay the rest over time), separate the actual cash portion from the noncash portion. Do not omit the entire purchase simply because part of it was financed.

What does the statement tell a reader?

Operating cash flow helps readers assess whether the business generates cash internally. Investing cash flows show where productive resources are acquired or released. Financing cash flows show the role of lenders and owners. Analyze the sections together and compare several periods.

Negative investing cash flow can reflect useful expansion. Positive financing cash flow can reflect new borrowing. Neither sign alone proves financial strength or weakness. Liquidity concerns short-term payment ability; solvency concerns meeting obligations over time; financial flexibility concerns adapting to financial needs and opportunities. The cash flow ratios and free cash flow tutorial applies these ideas quantitatively.

Common classification mistakes

• Calling every cash receipt revenue. A bank loan and a share issuance provide financing cash, not revenue.
• Calling every liability change financing. Ordinary operating accounts payable belong with operations; borrowing principal belongs with financing.
• Reporting depreciation as a cash payment. Depreciation allocates asset cost; it does not itself transfer cash.
• Hiding a noncash purchase. Excluding it from cash totals does not remove the separate disclosure requirement.

Practice: classify the transaction

1. A company pays $9,000 of loan principal and $600 of interest. Where do they go?

Answer: $9,000 is a financing outflow; $600 is an operating outflow under the ordinary U.S. GAAP rules. Split the payment by its nature.

2. A company issues $40,000 of shares directly for land. What cash flows arise?

Answer: None. Disclose the significant noncash investing and financing transaction separately. No cash was received or paid.

3. Cash from operations is $22,000, investing uses $31,000, and financing provides $15,000. Beginning cash is $8,000. What is ending cash?

Answer: $14,000. Net cash increases by $22,000 − $31,000 + $15,000 = $6,000. Add that increase to $8,000.

Preparing for an exam? Keep practicing with the CMA Exam Part 1 course or the CPA test bank.

Frequently asked questions

What are the three sections of the statement of cash flows?

Operating, investing, and financing activities. Operating covers cash from the day-to-day business. Investing covers buying and selling long-term assets and investments. Financing covers cash received from and paid to lenders and owners.

What is the difference between the direct method and the indirect method?

Both report the same operating cash flow. The direct method lists cash receipts and cash payments. The indirect method starts with net income and adjusts for noncash items, such as depreciation, and for changes in receivables, payables, and similar accounts.

Where do interest and dividends go on the statement of cash flows?

Under U.S. GAAP, interest paid, interest received, and dividends received are operating cash flows. Dividends paid are financing cash flows.

Can a company report a profit and still have negative cash flow?

Yes. Net income includes credit sales that have not been collected, and it leaves out cash spent on equipment and loan repayments. A company can report a profit while its cash balance falls.

Is a cash flow statement the same as an income statement?

No. Profit uses accrual-based revenues and expenses; cash flow reports cash movements. Credit sales and noncash expenses explain common differences.

Do the direct and indirect methods change investing and financing classification?

No. They are different presentations of operating cash flow. They produce the same operating total when correctly prepared from the same facts.

Does “cash” include cash equivalents?

Yes. Under ASC Topic 230, the statement explains the change in the total of cash, cash equivalents, restricted cash, and restricted cash equivalents. Cash equivalents are short-term, highly liquid investments, generally with original maturities of three months or less. The examples in this guide assume the company holds only cash. See the cash and cash equivalents guide and the restricted cash guide for definitions.

Is the classification the same under IFRS?

Not always. U.S. GAAP treats interest paid, interest received, and dividends received as operating cash flows. Before applying IFRS 18, International Financial Reporting Standards (IFRS) permit classification alternatives for certain interest and dividend cash flows under IAS 7, the international cash flow standard, applied consistently from period to period. IFRS 18 is effective for annual reporting periods beginning on or after January 1, 2027, with earlier application permitted. Under its amendments to IAS 7, companies that do not invest in assets or provide financing to customers as a main business activity classify interest paid and dividends paid as financing cash flows, and interest received and dividends received as investing cash flows. Different classification requirements apply to companies with those specified main business activities. See the IFRS Foundation’s IFRS 18 overview.

Sources and learning context

See the FASB Accounting Standards Codification, Topic 230, particularly classification and noncash disclosure guidance. FASB Statement 95, paragraphs 15–23 and 32, provides historical background to rules now codified.

About the author. Mansour Farhat, CPA, CIA, DBA, is the instructor behind Farhat Lectures and presents the video lesson on this page. Read more about Professor Farhat.