Understanding the Cash Flow Statement

Understanding the Cash Flow Statement

The cash flow statement, or the statement of cash flows, is a financial statement that summarizes cash equivalents and the amount of cash leaving and entering a company.

The cash flow statement – CFS measures how positively a company manages and generates the cash position. This indicates how the company can manage its cash to pay in funds and debt obligations. Furthermore, the statement complements the income statement and balance sheet. This procedure is considered a mandatory part of the financial reports of a company since 1987.

This article discusses how you can use it when analyzing a company and what is the structure of CFS.

Key Takeaways:

  • A cash flow statement is considered a financial statement summarizing cash equivalents and the amount of cash leaving and entering a company; 
  • The cash flow statement – CFS measures how positively a company manages and generates the cash position, which means how the company can manage its cash to pay in funds and debt obligations;
  • The cash flow statement complements the income statement and balance sheet that is a mandatory procedure of a company’s financial reports;
  • The main components are cash from investing activities, cash from operating activities, and cash from financing activities;
  • The two forms of calculating cash flow are the indirect method and the direct method.


How to Use a Cash Flow Statement

A cash flow statement is a financial statement that provides information on the cash inflows and outflows of a business over a specific period of time. It is an important tool for understanding a company’s financial health and can be used by business owners, investors, and creditors to make decisions about the company.

Here are the steps for using a cash flow statement:

  1. Start by reviewing the operating activities section of the statement, which shows the cash flows related to the company’s core business operations. This section will include information on cash received from customers, cash paid to suppliers and employees, and other operating expenses. This will help you understand how much cash is generated or used by the company’s day-to-day operations.
  2. Next, review the investing activities section, which shows the cash flows related to the company’s investments in assets such as property, plant, and equipment, and other long-term investments. This section will help you understand how much cash is being used to invest in the company’s future growth.
  3. Then, review the financing activities section, which shows the cash flows related to the company’s financing activities, such as issuing or repaying debt, issuing or buying back shares, and paying dividends. This section will help you understand how the company is funding its operations and growth.
  4. Finally, analyze the overall cash flow for the period. Positive cash flow means that the company generated more cash than it spent during the period, while negative cash flow means that the company spent more cash than it generated. This information will help you understand the company’s overall financial health and cash flow management.

By using the information provided in a cash flow statement, you can make informed decisions about investing in or lending to a company, or managing your own business’s cash flow.

The Structure of the Cash Flow Statement

The main components of the cash flow statement are:

  1. Cash from operating activities;
  2. Cash from investing activities;
  3. From financing activities;
  4. Disclosure of noncash activities.

It’s important to note that the CFS is different from the balance sheet and income statement because it does not include the amount of future outgoing and incoming cash recorded on credit.

Cash From Operating Activities

The operating activities on the CFS are any sources of cash and their use from business activities.

These operating activities may include:

  • Receipts from sales of services and goods
  • Interest payments
  • Income tax payments
  • Payments made to suppliers of services and goods used in production
  • Wage and salary payments to employees
  • Rent payments
  • Any other type of operating expenses

In the case of an investment company or trading a portfolio, there are some aspects included: receipts from the debt, sale of loans, or equity instruments. When preparing a cash flow depreciation statement under the indirect method, amortization, deferred gains, tax, losses, and revenue or dividends received from some investing activities are also included. However, sales or purchases of long-term assets are not included in operating activities.

How Cash Flow Is Calculated

Understanding the Cash Flow Statement

Cash flow can be calculated by making some adjustments to net income by subtracting or adding differences in expenses, revenue, and credit transactions resulting from transactions. Overall, because not all transactions involve actual cash items, most items must be re-evaluated while calculating cash flow from operations.

As a result, there are two methods of calculating cash flow: the indirect and direct methods.

Direct Cash Flow Method

The direct method adds all receipts and the various cash payments, including cash receipts, cash paid to suppliers, and money paid out in salaries. These numbers are calculated using the starting and ending balances of various business accounts and examining the net increase or decrease in the accounts.

Indirect Cash Flow Method

With the indirect method, cash flow is calculated by taking the net income of a company’s income statement with the indirect method. Revenue is recognized not when it is received but when it is earned because its income statement is prepared on an accrual basis.

Net income does not represent an accurate net cash flow from operating activities. The indirect method makes adjustments to add again the company’s non-operating activities that do not affect its operating cash flow.

For example, depreciation is a deducted amount from the total value of a previously accounted asset.

Cash From Investing Activities

Changes in assets, equipment, or investments are related to cash from investing.

Usually, cash changes are a cash-out item because they use cash to buy new buildings, equipment, or short-term assets such as marketable securities. When a company divests an investment, the transaction is cash in that is cash from investing.

Cash From Financing Activities

Cash from financing activities includes the sources of money from banks, investors or, shareholders. Payments for stock repurchases, payment of dividends, and the repayment of loans are also included in this category.

Negative Cash Flow Statement

Sometimes, negative cash flow results from a company’s decision after expanding its business, which might be good for the future. In fact, this is the reason why analyzing changes from one period to the other gives the investor a better idea about the company’s performance.

Balance Sheet and Income Statement

The cash flow statement is different from the income statement of the balance sheet.

In the CFS, the net cash flow should be equal to the increase or decrease of cash between the two balance sheets that apply to the time that the cash flow statement covers. For example, if you calculate cash flow for 2019, you should use the balance sheets from 2018 and 2019.

The Bottom Line

A cash flow statement for a company is a measure of profitability, strength, and the long-term future outlook. The CFS is able to help determine whether a company has enough cash or liquidity to pay its expenses. A company can also use a cash flow statement for predicting a future cash flow, which helps with budgeting.

For investors, the cash flow statement reflects a company’s financial health. The reason for this is that the more cash available for business operations, the better. However, this is not a hard rule. Sometimes, a negative cash flow results from a company’s growth strategy in expanding its operations.

An investor might get a clear view of how much money a company generates. Also, this person can gain a solid understanding of a company’s financial situation by studying the cash flow statement.