Your Money Revealed: Cash Flow Statements (2024)

One question is fundamental to any business: How much money is coming in versus how much isgoing out? A cash flow statement answers that and provides a clear picture of whether acompany has the cash it needs to pay its debts and fund operating expenses over a settimeframe. It’s one of the most important sources of insight into a company’s financialhealth.

What Is a Cash Flow Statement (CFS)?

A cash flow statement, also known as a statement of cash flows, is a financial statement thatdocuments the cash and cash equivalents a company generates and spends over a specificperiod. Cash flow statements reveal a business’s liquidity, help evaluate changes in assets,liabilities and equity, and make it easier when analysing operating performance.

Key takeaways

• Cash flow statements show the cash impact of the decisions a company makes on operating,investing and financing activities.
• A cash flow statement consists of three sections: cash from operating activities, cashfrom investing activities and cash from financing activities.
• There are two methods for cash flow statement preparation: direct and indirect.
• The direct method determines changes in cash receipts and payments. The indirect methodtakes the net income generated in a period and adds or subtracts changes in the assetand liability accounts to determine the implied cash flow.
• A key component for any company are the changes in accounts receivable.
• Investing activities should include asset purchases and sales, interest paid on loans,and payments related to mergers and acquisitions.
• Negative cash flow is not always a cause for alarm; some businesses choose to spend moreto meet business goals and may rely on financing to get them to positive cash flowgeneration.

Why Do Businesses Need Cash Flow Statements?

The cash flow statement serves as a bridge between the income statement and the balancesheet. There are four key reasons why a cash flow statement is important:

1. It reveals a business’ liquidity so that companies know just how much cash is on hand,and thus their projected runway to when cash is projected to run out.
2. It details the specific changes in assets, liabilities and equity.
3. It eliminates the effects of different bookkeeping techniques (for example cash basisversus accrual basis accounting), making it easier for investors to compare multiplefirms’ financial performance.
4. It helps analyse and forecast the amount, timing and probability of future cash needs.

How Cash Flow Statements Work

All publicly traded companies must file financial reports and statements with the Securitiesand Exchange Commission (SEC). The cash flow statement is one of three critical documents,along with the balance sheet and income statement, included in SEC filings. It providesinformation about cash receipts, cash payments and the net change in cash resulting from acompany’s operating, investing and financing activities.

Investors look to the cash flow statement for insights into a company’s financial footing.Meanwhile, creditors can use the cash flow statement to gauge liquidity and determinewhether a company can fund its operating expenses and pay off its debts.

What Is Included in a Cash Flow Statement?

A cash flow statement consists of three key components:

• Cash flow from operating activities involves any cash flows fromcurrent assets and current liabilities. This section includes transactions from alloperational business activities, including buying and selling inventory and supplies aswell as paying employee salaries.
• Cash flow from investing activities reflects results from investmentgains and losses. This section includes transactions such as equipment purchases, loansmade to suppliers or mergers and acquisitions. Analysts can rely on this section to findchanges in capital expenditures (CapEx).
• Cash flow from financing activities measures cash flow between acompany and its owners and creditors. This section involves cash transactions related toraising money from stock or debt or repaying that debt. When cash flow from financingactivities contains a positive number, it’s a sign that there is more cash inflow thanoutflow. When the number is negative, it may indicate that a company is paying off debt,making dividend payments or buying back stock.

Additionally, the cash flow statement may include disclosure of non-cash activities whenprepared under generally accepted accounting principles (GAAP)—items like fixed assetdepreciation, goodwill amortisation and the like.

How is a Cash Flow Statement Produced?

There are two methods of cash flow statement preparation: direct and indirect. The bestchoice for your business depends on how much detail you need to include in your statement,as well as how much time you are willing to dedicate. While both methods are GAAP-approved,the International Accounting Standards Board (IASB) prefers the direct reporting method.However, most small businesses use the indirect method.

Direct vs. Indirect Methods of Producing a Cash Flow Statement

The main difference between the direct method and the indirect method of presenting thestatement of cash flows (SCF) involves the cash flows from operating activities. There areno differences in the cash flows from investing activities and the cash flows from financingactivities under either method—the real difference lies in the operating activities.

• Direct cash flow method: This method relies on cash-basis accounting.Finance records revenues and expenses as cash is received or disbursed by the business.The direct method requires more organisation and legwork, since you subtract actual cashflows from inflows. Common line items using this method include customer receipts,payments to suppliers and employees, interest and dividends received and income taxpayments.
• Indirect cash flow method: This method is based on accrual-basisaccounting, meaning revenue and expenses are counted when they are incurred rather thanwhen money actually changes hands. Finance looks at the transactions recorded on theincome statement and selectively reverses some of them to eliminate transactions thatdon’t show the movement of cash. This method also requires adjustments to add back anynon-operating activities, such as depreciation, that don’t impact operating cash flow.

Accounts Receivable and Cash Flow

When it comes to the balance sheet, any changes in accounts receivablemust be reflected in cash flow. A decrease in accounts receivable implies that more cash hasentered the company from customers paying off credit accounts. The amount accountsreceivable decreased is added to the company’s net sales. However, if accounts receivableincreases, the amount of the increase must be deducted from net sales. That’s because, whileaccounts receivable amounts count as revenue, they are not cash.

Inventory Value and Cash Flow

When inventory increases, itindicates that a company has spent money on raw materials. If cash were used in the purchaseof that inventory, the increase would be deducted from net sales. On the flip side, if therewere a decrease in inventory, that would be added to net sales. If the inventory waspurchased on credit instead of cash, the balance sheet would reflect an increase in accounts payable, andthat year-over-year increase would be added to net sales.

Investing Activities and Cash Flow

Cash From Financing Activities

Financing activities involve both cash inflows and outflows from creditors. This categorycomprises the money that comes from investors or banks, dividend payments, and goes out forstock repurchases and the repayment of loans.

Not all financing activities involve the use of cash, and only activities that impact cashare reported in the cash flow statement. Non-cash financing activities include theconversion of debt to common stock or issuing a bond payable to discharge the liability.

A business’ financing activities shed light on its overall financial health and goals. Forexample, positive cash flow from financing activities is indicative of growth and expansion.More money flowing into a business signifies an increase in business assets. Meanwhile, cashoutflows from financing activities can signify improved liquidity. It may mean that acompany has paid off long-term debt or made a dividend payment to shareholders.

Negative Cash Flow Statements

In general, a positive cash flow statement is a sign of a healthy company. And yet a negativecash flow statement is not in itself cause for alarm. It may mean a business is new and hasspent a lot of money on property or equipment. Or, it could mean the business is in growthmode.

For example, Netflix had a negative cashflow for years while the company increased spending on original content. It was agamble, but some investors saw the strategy as a positive. More original content meant thebusiness would be better equipped to compete with other streaming services and TV networks.

Balance Sheet and Income Statement

The cash flow statement serves as a bridge between the income statement and the balance sheetby showing how cash moves in and out of a business during a specific period. The balancesheet involves a company’s assets and liabilities from one period to the next while theincome statement covers expenses and income over time.

Finance can reference both the balance sheet and the income statement while preparing a cashflow statement. The net cash flow in the cash flow statement between periods should equalthe change in cash between consecutive balance sheets of the period that the cash flowstatement covers. The cash flow statement is formulated by subtracting non-cash items fromthe income statement.

Cash Flow Statement Example

Below is an example of a cash flow statement for Macy’s department stores.