Cash Flow Statement: How to Read and Understand It (2024)

What Is a Cash Flow Statement?

A cash flow statement is a financialstatement thatprovides aggregate data regarding all cash inflows that a company receives from its ongoing operations and external investment sources. It also includes all cash outflows that pay for business activities and investments during a given period.

A company’s financial statements offer investors and analysts a portrait of all the transactions that go through the business, where every transaction contributes to its success. The cash flow statement is believed to be the most intuitive of all the financial statements because it follows the cash made by the business in three main ways: through operations, investment, and financing. The sum of these three segments is called net cash flow.

These three different sections of the cash flow statement can help investors determine the value of a company’s stock or the company as a whole.

Key Takeaways

  • A cash flow statement provides data regarding all cash inflows that a company receives from its ongoing operations and external investment sources.
  • The cash flow statement includes cash made by the business through operations, investment, and financing—the sum of which is called net cash flow.
  • The first section of the cash flow statement is cash flow from operations, which includes transactions from all operational business activities.
  • Cash flow from investment is the second section of the cash flow statement, and is the result of investment gains and losses.
  • Cash flow from financing is the final section, which provides an overview of cash used from debt and equity.

How Cash Flow Statements Work

Every company that sells and offers its stock to the public must file financial reports and statements with the U.S. Securities and Exchange Commission (SEC). The three main financial statements are the balance sheet, income statement, and cash flow statement. The cash flow statement is an important document that helps interested parties gain insight into all the transactions that go through a company.

There are two different branches of accounting: accrual and cash. Most public companies use accrual accounting, which means that the income statementis not the same as the company’s cash position. The cash flow statement, though, is focused on cash accounting.

Profitable companies can fail to adequately manage cash flow, which is why the cash flow statement is a critical tool for companies,analysts, and investors. The cash flow statement is broken down into threedifferent business activities: operations, investing, and financing.

Let’s consider a company that sells a product and extends credit for the sale to its customer. Even though It recognizes that sale as revenue, the company may not receive cash until a later date. Thecompany earns a profit on the income statement and pays income taxeson it, but the business may bring in more or less cash than the sales or income figures.

Investors and analysts should use good judgment when evaluating changes to working capital, as some companies may try to boost up their cash flow before reporting periods.

Cash Flows from Operations

The first section of the cash flow statement covers cash flows from operating activities (CFO) and includes transactions from all operational business activities. The cash flows from operations section beginswith net income, then reconciles all non-cash items to cash items involvingoperational activities. In other words, it is the company’s net income, but in a cash version.

This section reports cash flows and outflows that stem directly from a company’s main business activities. These activities may include buying and selling inventory and supplies, along with paying its employees their salaries. Any other forms of inflows and outflows such as investments, debts, and dividends are not included.

Companies are able to generate sufficient positive cash flow for operational growth. If not enough is generated, they may need to secure financing for external growth to expand.

For example, accounts receivable is a non-cash account. If accounts receivable go up during a period, it means sales are up, but no cash was received at the time of sale. The cash flow statement deducts receivables from net income because it is not cash. The cash flows from the operationssection canalso includeaccounts payable, depreciation, amortization, and numerous prepaid items booked as revenue or expenses, but with no associated cash flow.

Cash Flows from Investing

This is the second section of the cash flow statement. It looks at cash flows from investing (CFI) and is the result of investment gains and losses. This section also includes cash spent on property, plants, and equipment. This section is where analysts look to find changes in capital expenditures (CapEx).

When CapEx increases, it generally means there is a reduction in cash flow. But that’s not always a bad thing, as it may indicate that a company is making investment into its future operations. Companies with high CapEx tend to be those that are growing.

While positive cash flows within this section can be considered good, investors wouldprefer companies that generate cash flowfrom business operations—not through investing and financing activities. Companies can generate cash flow within this sectionby selling equipment or property.

Cash Flows from Financing

Cash flows from financing (CFF) is the last section of the cashflow statement. The section provides an overview of cash used in business financing. It measures cash flow between a company and its owners and its creditors, and its source is normally from debt or equity. These figures are generally reported annually on a company’s 10-K report to shareholders.

Analysts use the cash flows from financing section to determine how much money the company haspaid out via dividends or share buybacks. It is also useful to help determine how a company raises cash for operational growth.

Cash obtained or paid back from capital fundraising efforts, such as equity or debt, is listed here, as areloans taken out or paid back.

When the cash flow from financing is a positive number, it means there is more money coming into the company than flowing out. When the number is negative, it may mean the company is paying off debt or is making dividend payments and/or stock buybacks.

Which Kinds of Cash Flows Show Up in Operations?

Cash inflows and outflows from business activities such as buying and selling inventory and supplies, paying salaries, accounts payable, depreciation, amortization, and prepaid items booked as revenues and expenses.

When Capital Expenditures Increase, What Happens to Cash Flow?

Generally, cash flow is reduced, as the cash has been used to invest in future operations, thus promoting future growth of the company.

What Does a Negative Cash Flow From Financing Mean?

A negative number can show that a company is paying off debt, making dividend payments or buying back its stock.

The Bottom Line

The cash flow statement has three key sections: cash flow from operations, cash flow from investments and cash flow from financing. Even if the business uses accrual accounting as its main reporting system, the cash flow statement is focused on cash accounting. The cash flow statement enables managers, analysts, and investors to assess how well a company is doing. Overall investors prefer that companies generate the bulk of their cash flow from operations, rather than from investments and financing.

Cash Flow Statement: How to Read and Understand It (2024)


How do you read and understand cash flow? ›

To interpret your company's cash flow statement, start by looking at the inflows and outflows of cash for each category: operating activities, investing activities, and financing activities. If all three areas show positive cash flow, your business is likely doing well (although there are exceptions).

How do you analyze a cash flow statement? ›

One can conduct a basic cash flow analysis by examining the cash flow statement, determining whether there is net negative or positive cash flow, pinpointing how the outflows compare to inflows, and draw conclusions from that.

What is the cash flow statement easily explained? ›

A cash flow statement tells you how much cash is entering and leaving your business in a given period. Along with balance sheets and income statements, it's one of the three most important financial statements for managing your small business accounting and making sure you have enough cash to keep operating.

How to tell if a cash flow statement is good? ›

How to know if a cash flow statement is good or bad? A good cash flow statement demonstrates positive cash flow and positive operating cash flow, in addition to rational investing and financing activities.

What is the rule of thumb for the statement of cash flows? ›

The standard rule of thumb is to subtract the increase of asset accounts from net income, and add the decrease of asset accounts to net income. The opposite rule applies to liabilities here.

What is the most important number on a statement of cash flows? ›

Regardless of whether the direct or the indirect method is used, the operating section of the cash flow statement ends with net cash provided (used) by operating activities. This is the most important line item on the cash flow statement.

What is a good cash flow ratio? ›

A high number, greater than one, indicates that a company has generated more cash in a period than what is needed to pay off its current liabilities. An operating cash flow ratio of less than one indicates the opposite—the firm has not generated enough cash to cover its current liabilities.

What is cash flow analysis answer? ›

Cash flow analysis refers to the evaluation of inflows and outflows of cash in an organisation obtained from financing, operating and investing activities. In other words, we can say that it determines the ways in which cash is earned by the company.

What are the problems with the cash flow statement? ›

Some common problems with the cash flows statement are the following: Classification differences between the operating statement and the cash flows statement. Noncash activities. Internal consistency issues between the general purpose financial statements.

Is cash flow the same as profit? ›

So, is cash flow the same as profit? No, there are stark differences between the two metrics. Cash flow is the money that flows in and out of your business throughout a given period, while profit is whatever remains from your revenue after costs are deducted.

What is a cash flow example? ›

Example of a Cash Flow Statement

The purchasing of new equipment shows that the company has the cash to invest in itself. Finally, the amount of cash available to the company should ease investors' minds regarding the notes payable, as cash is plentiful to cover that future loan expense.

What should a business do if it has a negative cash flow? ›

Negative cash flow isn't necessarily a bad thing if you're following a plan. However, you want to avoid running out of cash entirely. To avoid this situation or simply to improve your business cash flow, you may want to consider exploring available business funding sources.

What is a cash flow statement and why is it significant? ›

The cash flow statement is a solid measure of a company's strength, profitability, and future outlook of a company. The importance of the cash flow statement is that it measures the cash inflows or cash outflows during the given period of time. This knowledge informs the company's short- and long-term planning.

What is the difference between a balance sheet and a cash flow statement? ›

A balance sheet shows what a company owns in the form of assets and what it owes in the form of liabilities. A balance sheet also shows the amount of money invested by shareholders listed under shareholders' equity. The cash flow statement shows the cash inflows and outflows for a company during a period.

What is the difference between the income statement and the cash flow statement? ›

The cash flow statement follows the cash basis of accounting that works on the actual payments and receipts of cash. The income statement follows the accrual basis of accounting that works on the basis of income/payments that are either due or received in advance.

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