Cash Flow Statement

What Is a Cash Flow Statement?
The statement of cash flows, or the cash flow statement, is a financial statement that summarizes the
amount of cash and cash equivalents entering and leaving a company.
The cash flow statement (CFS) measures how well a company manages its cash position, meaning how
well the company generates cash to pay its debt obligations and fund its operating expenses. The cash
flow statement complements the balance sheet and income statement and is a mandatory part of a
company's financial reports since 1987.
How to Use a Cash Flow Statement

The CFS allows investors to understand how a company's operations are running, where its money is
coming from, and how money is being spent. The CFS is important since it helps investors determine
whether a company is on a solid financial footing.
Creditors, on the other hand, can use the CFS to determine how much cash is available (referred to as
liquidity) for the company to fund its operating expenses and pay its debts.
The Structure of the CFS

The main components of the cash flow statement are:
1. Cash from operating activities

2. Cash from investing activities
3. Cash from financing activities
4. Disclosure of noncash activities is sometimes included when prepared under the generally
accepted accounting principles, or GAAP
It's important to note that the CFS is distinct from the income statement and balance sheet because it
does not include the amount of future incoming and outgoing cash that has been recorded on credit.
Therefore, cash is not the same as net income, which on the income statement and balance sheet,
includes cash sales and sales made on credit.
Operating Activities
The operating activities on the CFS include any sources and uses of cash from business activities. In
other words, it reflects how much cash is generated from a company's products or services.
These operating activities might include:
 Receipts from sales of goods and services

 Interest payments
 Income tax payments
 Payments made to suppliers of goods and services used in production
 Salary and wage payments to employees
 Rent payments
 Any other type of operating expenses
In the case of a trading portfolio or an investment company, receipts from the sale of loans, debt, or
equity instruments are also included. When preparing a cash flow statement under the indirect method,
depreciation, amortization, deferred tax, gains or losses associated with a noncurrent asset, and
dividends or revenue received from certain investing activities are also included. However, purchases or
sales of long-term assets are not included in operating activities.
How Cash Flow Is Calculated

Cash flow is calculated by making certain adjustments to net income by adding or subtracting
differences in revenue, expenses, and credit transactions (appearing on the balance sheet and income
statement) resulting from transactions that occur from one period to the next. These adjustments are
made because non-cash items are calculated into net income (income statement) and total assets and
liabilities (balance sheet). So, because not all transactions involve actual cash items, many items have to
be re-evaluated when calculating cash flow from operations.
As a result, there are two methods of calculating cash flow, the direct method, and the indirect method.
Direct Cash Flow Method

The direct method adds up all the various types of cash payments and receipts, including cash paid to
suppliers, cash receipts from customers and cash paid out in salaries. These figures are calculated by
using the beginning and ending balances of a variety of business accounts and examining the net
decrease or increase in the accounts.
Indirect Cash Flow Method

With the indirect method, cash flow from operating activities is calculated by first taking the net income
off of a company's income statement. Because a company’s income statement is prepared on an accrual
basis, revenue is only recognized when it is earned and not when it is received. Net income is not an
accurate representation of net cash flow from operating activities, so it becomes necessary to adjust
earnings before interest and taxes (EBIT) for items that affect net income, even though no actual cash
has yet been received or paid against them. The indirect method also makes adjustments to add back
non-operating activities that do not affect a company's operating cash flow.
For example, depreciation is not really a cash expense; it is an amount that is deducted from the total
value of an asset that has previously been accounted for. That is why it is added back into net sales for
calculating cash flow.
Accounts Receivable and Cash Flow
Changes in accounts receivable (AR) on the balance sheet from one accounting period to the next must
also be reflected in cash flow. If accounts receivable decreases, this implies that more cash has entered
the company from customers paying off their credit accounts—the amount by which AR has decreased
is then added to net sales. If accounts receivable increases from one accounting period to the next, the
amount of the increase must be deducted from net sales because, although the amounts represented in
AR are revenue, they are not cash.
Inventory Value and Cash Flow

An increase in inventory, on the other hand, signals that a company has spent more money to purchase
more raw materials. If the inventory was paid with cash, the increase in the value of inventory is
deducted from net sales. A decrease in inventory would be added to net sales. If inventory was
purchased on credit, an increase in accounts payable would occur on the balance sheet, and the amount
of the increase from one year to the other would be added to net sales.
The same logic holds true for taxes payable, salaries payable, and prepaid insurance. If something has
been paid off, then the difference in the value owed from one year to the next has to be subtracted
from net income. If there is an amount that is still owed, then any differences will have to be added to
net earnings.
Investing Activities and Cash Flow

Investing activities include any sources and uses of cash from a company's investments. A purchase or
sale of an asset, loans made to vendors or received from customers or any payments related to a
merger or acquisition is included in this category. In short, changes in equipment, assets, or investments
relate to cash from investing.
Usually, cash changes from investing are a "cash out" item, because cash is used to buy new equipment,
buildings, or short-term assets such as marketable securities. However, when a company divests an
asset, the transaction is considered "cash in" for calculating cash from investing.
Cash from Financing Activities

Cash from financing activities include the sources of cash from investors or banks, as well as the uses of
cash paid to shareholders. Payment of dividends, payments for stock repurchases and the repayment of
debt principal (loans) are included in this category.
Changes in cash from financing are "cash in" when capital is raised, and they're "cash out" when
dividends are paid. Thus, if a company issues a bond to the public, the company receives cash financing;
however, when interest is paid to bondholders, the company is reducing its cash.
Negative Cash Flow Statements

Of course, not all cash flow statements look this healthy or exhibit a positive cash flow, but negative
cash flow should not automatically raise a red flag without further analysis. Sometimes, negative cash
flow is the result of a company's decision to expand its business at a certain point in time, which would
be a good thing for the future. This is why analyzing changes in cash flow from one period to the next
gives the investor a better idea of how the company is performing, and whether or not a company may
be on the brink of bankruptcy or success.
Balance Sheet and Income Statement

As we have already discussed, the cash flow statement is derived from the income statement and the
balance sheet. Net earnings from the income statement are the figure from which the information on
the CFS is deduced. As for the balance sheet, the net cash flow in the CFS from one year to the next
should equal the increase or decrease of cash between the two consecutive balance sheets that apply to
the period that the cash flow statement covers. (For example, if you are calculating cash flow for the
year 2019, the balance sheets from the years 2018 and 2019 should be used.)

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What Is a Cash Flow Statement?

How to Use a Cash Flow Statement

The Structure of the CFS

1. Cash from operating activities

These operating activities might include:

 Receipts from sales of goods and services

How Cash Flow Is Calculated

Direct Cash Flow Method

Indirect Cash Flow Method

Inventory Value and Cash Flow

Investing Activities and Cash Flow

Cash from Financing Activities

Negative Cash Flow Statements

Balance Sheet and Income Statement

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