FAR CPA Practice Questions Explained: The Purpose of the Statement of Cash Flows for a Not-For-Profit Entity

In this video, we walk through 3 FAR practice questions teaching about the purpose of the statement of cash flows for a not-for-profit entity. These questions are from FAR content area 1 on the AICPA CPA exam blueprints: Financial Reporting.

The best way to use this video is to pause each time we get to a new question in the video, and then make your own attempt at the question before watching us go through it.

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The Purpose of the Statement of Cash Flows for a Not-For-Profit Entity

The statement of cash flows for a nongovernmental, not-for-profit entity is a financial report that provides insight into the organization’s cash activities over a specific period. Its primary purpose is to present a detailed account of how cash is generated and utilized, allowing stakeholders to assess the entity’s financial health, liquidity, and overall sustainability.

Purpose of the Statement of Cash Flows

The main purpose of the statement of cash flows is to show the cash inflows and outflows of the nonprofit organization during a specific period, typically broken down into three categories:

1. Operating Activities: This section reflects the cash flows related to the core mission-driven activities of the nonprofit. It includes cash received from donors, grants, and other sources of operating income, as well as cash paid for expenses like salaries, supplies, and program services. For nonprofits using the indirect method, this section begins with the “change in net assets,” which is analogous to starting with net income in a for-profit entity.
2. Investing Activities: This section captures cash flows from the acquisition and disposal of long-term assets, such as property, equipment, or investments. For a nonprofit, investing activities might include purchasing or selling investments, acquiring new facilities, or spending on long-term projects.
3. Financing Activities: Financing activities for a nonprofit often involve cash flows related to borrowing, repayment of loans, or receipt of contributions restricted for long-term purposes. These activities may also include the issuance or repayment of debt.

Objectives of the Statement of Cash Flows

The objectives of the statement of cash flows are closely aligned with the needs of various stakeholders, including donors, board members, management, and regulators. Key objectives include:

1. Assessing Liquidity and Financial Health: The statement of cash flows provides a clear view of the nonprofit’s ability to generate cash to meet its obligations, sustain operations, and invest in future activities. By analyzing the cash flows, stakeholders can determine whether the organization has sufficient cash to continue its mission and meet its financial commitments.
2. Understanding the Impact of Operating Activities: This statement highlights how the nonprofit’s core operations contribute to its cash position. It reveals whether the organization is generating enough cash from its mission-driven activities to cover its operating costs, or if it is relying heavily on financing or investing activities to stay afloat.
3. Evaluating Cash Flow Management: The statement of cash flows allows stakeholders to see how effectively the nonprofit manages its cash resources. It shows whether the organization is using cash wisely, investing in projects that align with its mission, and maintaining adequate reserves to weather financial challenges.
4. Comparing Cash Flows with Financial Statements: The statement of cash flows complements the statement of financial position (balance sheet) and the statement of activities (income statement). It provides a reconciliation between the change in net assets (or net income in a for-profit context) and the actual cash generated or used during the period, offering a more comprehensive view of the nonprofit’s financial performance.

Key Differences Between Nonprofit and For-Profit Cash Flow Statements

While the structure and purpose of the statement of cash flows are similar between nonprofits and for-profits, there are some important differences:

• Terminology: Nonprofits use terms like “change in net assets” instead of “net income” to reflect their mission-focused nature.
• Sources of Cash Inflows: Nonprofits often rely on donations, grants, and contributions, which can affect how operating activities are presented.
• Classification of Activities: Specific items within operating, investing, and financing activities may differ due to the nature of nonprofit operations, such as handling restricted contributions and donor-imposed restrictions.
• Supplemental Disclosures: Nonprofits may need to provide additional information related to donor restrictions and the use of restricted cash.

Methods for Preparing the Statement of Cash Flows

Nongovernmental, not-for-profit entities can prepare the statement of cash flows using either the direct method or the indirect method, just like for-profit entities. The direct method lists cash receipts and payments, providing a straightforward view of cash flows. The indirect method, which is more commonly used, begins with the change in net assets and adjusts for non-cash items and changes in working capital. Although the Financial Accounting Standards Board (FASB) encourages the use of the direct method, nonprofits can choose either method, depending on their preference and the level of detail they wish to present.