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The cash flow statement is one of the key financial statements a company needs to prepare in line with US GAAP and IFRS. It presents the cash flows for the period and it reconciles to the cash and cash equivalents number on the balance sheet.

The document also shows a company’s ability to generate cash and meet any future cash flow obligations all within a given time period e.g. quarterly, annually. Unlike the income statement, which is based on accrual accounting (transactions are reported when income or earnings are recognized, not when cash is received), a cash flow will instead show the movement of cash.

The statement can be broken down into four main components which summarize the cash flows from operating, investing and financing activities, as well as the reconciliation of net cash flow to cash and cash equivalents.

Operating Cash Flows

Operating cash flows are those produced and used by the operations of the business. These activities are directly related to providing the actual product or service. There are two methodologies to present these cash flows; direct method and indirect method. The former is rare in practice as most businesses present operating cash flows using the indirect method.

The section begins with net income reported from the income statement and adjusts for the impact of non-cash items, such as sales made on credit or depreciation expenses.

For the majority of businesses, the cash flows from operations should be positive year on year since the future of the business is in jeopardy if these are negative on an ongoing basis.

Investing Cash Flows

The second section of the statement presents cash flows invested in the future of the business or released by divesting long-term assets. This section includes the purchase of PP&E and other capex expenses.

An analyst would expect the cash flows relating to investing activities to be negative since the business should be buying new assets frequently. This would suggest that the company is growing by continuing to invest in its future operations.

Positive cash flow in this section would suggest the company is divesting its long-term assets. Generally, significant asset divestment should not be undertaken on a regular basis and investors would prefer the company to generate positive cash flows through its operations.

Financing Cash Flows

Cash flows from financing activities record the flows to and from the providers of both equity and debt financing. This section can be positive or negative depending on the relative amounts of issuance or redemption in a given period. A positive financing cash flow number shows money is coming into the business rather than flowing out. Negative cash flow indicates the company is paying debt holders or paying dividends.

Analysts review this section to determine how much money a business has paid out to its shareholders in the form of dividends. This section is also a good indication of how a company raises capital to fund its operations.

Reconciliation of Net Cash Flows

The final section of the statement shows the net cash flow or the sum of the operating, investing and financing flows. When added to the cash and cash equivalents at the start of the period it should equal the ending amount in the balance sheet. In other words, the cash flow explains the change in cash and cash equivalents between the prior period and the current period end.

What can be Learnt from a Cash Flow Statement?

  • Investors highly favour cash and it might often be quoted that “cash is king”. It’s attractive for an investor if the company can report a highly positive cash flow. The company can choose to increase its dividend, buy back stock, reduce its liabilities in the form of debts or acquire another company.
  • It will now be possible to compare the net income with cash from operating activities. A higher value for cash due to operating activities than net income will mean a higher quality of earnings.
  • We can also establish a company’s growth profile. Very fast growing or start-up businesses will often have negative operating and investing cash flows, and these will be financed by the cash flow from financing. Mature businesses will often have very positive cash flow from operations, small negative cash flow from investing (supporting maintenance capex), and very negative cash flow from financing, as funds are repatriated to investors.

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