Understanding the Cash Flow Statement

The cash flow statement ( CFS ), is a fiscal affirmation that summarizes the bowel movement of cash and cash equivalents ( CCE ) that come in and go away of a company. The CFS measures how well a company manages its cash place, meaning how well the company generates cash to pay its debt obligations and fund its operating expenses. As one of the three independent fiscal statements, the CFS complements the balance sheet and the income statement. In this article, we ’ ll show you how the CFS is structured and how you can use it when analyzing a company .

Key Takeaways

  • A cash flow statement summarizes the amount of cash and cash equivalents entering and leaving a company. 
  • The CFS highlights a company’s cash management, including how well it generates cash. 
  • This financial statement complements the balance sheet and the income statement. 
  • The main components of the CFS are cash from three areas: Operating activities, investing activities, and financing activities.
  • The two methods of calculating cash flow are the direct method and the indirect method.


What Is a Cash Flow Statement?

How the Cash Flow Statement Is Used

The cash menstruate affirmation paints a picture as to how a ship’s company ’ south operations are running, where its money comes from, and how money is being spent. besides known as the affirmation of cash flows, the CFS helps its creditors determine how a lot cash is available ( referred to as liquid ) for the company to fund its operate expenses and pay down its debts. The CFS is equally angstrom important to investors because it tells them whether a company is on solid fiscal establish. As such, they can use the affirmation to make better, more inform decisions about their investments .

social organization of the Cash Flow Statement

The main components of the cash stream statement are :

cash from operate Activities

The operating activities on the CFS include any sources and uses of cash from commercial enterprise activities. In other words, it reflects how much cash is generated from a company ’ mho products or services .

These function 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 trade portfolio or an investing company, receipts from the sale of loans, debt, or equity instruments are besides included because it is a commercial enterprise bodily process .

Changes made in cash, accounts receivable, depreciation, inventory, and accounts account payable are broadly reflected in cash from operations .

cash from Investing Activities

Investing activities include any sources and uses of cash from a company ’ s investments. Purchases or sales of assets, loans made to vendors or received from customers, or any payments related to mergers and acquisitions ( M & A ) are included in this category. In short-change, changes in equipment, assets, or investments relate to cash from investing .

Changes in cash from investing are normally considered cash-out items because cash is used to buy newfangled equipment, buildings, or short-run assets such as marketable securities. But when a company divests an asset, the transaction is considered cash-in for calculating cash from investing .

cash from finance Activities

cash from finance activities includes the sources of cash from investors and banks, american samoa well as the means cash is paid to shareholders. This includes any dividends, payments for livestock repurchases, and repayment of debt principal ( loans ) that are made by the ship’s company .

Changes in cash from finance are cash-in when capital is raised and cash-out when dividends are paid. thus, if a company issues a bond to the populace, the company receives cash financing. however, when interest is paid to bondholders, the caller is reducing its cash. And remember, although sake is a cash-out expense, it is reported as an operational activity—not a finance bodily process .

How Cash Flow Is Calculated

There are two methods of calculating cash menstruate : the direct method and the indirect method .

direct Cash Flow Method

The   steer method acting   adds up all of the cash payments and receipts, including cash paid to suppliers, cash receipts from customers, and cash paid out in salaries. This method of CFS is easier for very small businesses that use the cash basis accountancy method .

These figures can besides be calculated by using the beginning and ending balances of a variety of asset and liability accounts and examining the net decrease or increase in the accounts. It is presented in a straightforward manner .

Most companies use the accumulation basis accounting method. In these cases, tax income is recognized when it is earned quite than when it is received. This causes a unplug between net income income and actual cash flow because not all transactions in net income on the income instruction involve actual cash items. therefore, certain items must be reevaluated when calculating cash menstruation from operations .

indirect Cash Flow Method

With the indirect method, cash flow is calculated by adjusting net income by adding or subtracting differences resulting from non-cash transactions. Non-cash items show up in the changes to a company ’ mho assets and liabilities on the balance wheel sheet from one menstruation to the next. therefore, the accountant will identify any increases and decreases to asset and liability accounts that need to be added back to or removed from the net income trope, in order to identify an accurate cash inflow or outflow.

Changes in accounts receivable ( AR ) on the balance tabloid from one account period to the future must be reflected in cash flow :

  • If AR decreases, more cash may have entered the company from customers paying off their credit accounts—the amount by which AR has decreased is then added to net earnings.
  • An increase in AR must be deducted from net earnings because, although the amounts represented in AR are in revenue, they are not cash.

What about changes in a ship’s company ‘s inventory ? here ‘s how they are accounted for on the californium :

  • An increase in inventory signals that a company spent more money on raw materials. Using cash means the increase in the inventory’s value is deducted from net earnings.
  • A decrease in inventory would be added to net earnings. Credit purchases are reflected by an increase in accounts payable on the balance sheet, and the amount of the increase from one year to the next is added to net earnings.

The lapp logic holds true for taxes account payable, salaries, and prepaid policy. If something has been paid off, then the remainder in the value owed from one year to the future has to be subtracted from net income. If there is an amount that is however owed, then any differences will have to be added to net earnings .

Limitations of the Cash Flow Statement

negative cash run should not automatically raise a bolshevik flag without far analysis. Poor cash flow is sometimes the result of a company ’ s decision to expand its clientele at a certain sharpen in time, which would be a good thing for the future .

Analyzing changes in cash run from one menstruation to the following gives the investor a better idea of how the company is performing, and whether a company may be on the brink of bankruptcy or achiever. The CFS should besides be considered in unison with the early two fiscal statements.

The indirect cash stream method allows for a reconciliation between two other fiscal statements : the income affirmation and proportion sail.

Cash Flow Statement vs. Income Statement vs. Balance Sheet

The cash flow statement measures the performance of a company over a period of time. But it is not as easily manipulated by the time of non-cash transactions. As noted above, the CFS can be derived from the income statement and the balance sheet. net earnings from the income argument are the figure from which the information on the CFS is deduced. But they only factor into determining the manoeuver activities section of the CFS. As such, final earnings have nothing to do with the investing or fiscal activities sections of the CFS .

The income statement includes disparagement expense, which does n’t actually have an associated cash outflow. It is just an allotment of the cost of an asset over its useful life. A company has some leeway to choose its disparagement method, which modifies the depreciation expense reported on the income statement. The CFS, on the early hand, is a measure of true inflows and outflows that can not be as well manipulated .

As for the libra sheet, the net cash flow reported on the CFS should equal the net change in the assorted line items reported on the balance wheel sail. This excludes cash and cash equivalents and non-cash accounts, such as roll up depreciation and accumulated amortization. For exercise, if you calculate cash flow for 2019, make sure you use 2018 and 2019 balance sheets.

The CFS is discrete from the income statement and the balance sheet because it does not include the come of future incoming and outgoing cash that has been recorded as revenues and expenses. consequently, cash is not the same as net income, which includes cash sales angstrom good as sales made on credit on the income statements.

exercise of a Cash Flow Statement

Below is an case of a cash menstruate affirmation :

image by Sabrina Jiang © Investopedia 2020
From this CFS, we can see that the net cash flow for the 2017 fiscal year was $ 1,522,000. The bulk of the positive cash menstruation stems from cash earned from operations, which is a effective sign for investors. It means that core operations are generating business and that there is enough money to buy new stock .

The buying of new equipment shows that the party has the cash to invest in itself. finally, the come of cash available to the company should ease investors ’ minds regarding the notes collectible, as cash is bountiful to cover that future lend expense.

What Is the Difference Between Direct and Indirect Cash Flow Statements?

The remainder lies in how the cash inflows and outflows are determined. Using the direct method, actual cash inflows and outflows are known amounts. The cash stream argument is reported in a square manner, using cash payments and receipts. Using the collateral method acting, actual cash inflows and outflows do not have to be known. The indirect method begins with net income or passing from the income affirmation, then modifies the digit using balance sheet account increases and decreases, to compute implicit cash inflows and outflows .

Is the Indirect Method of the Cash Flow Statement Better Than the Direct Method?

Neither is necessarily better or worse. however, the indirect method besides provides a entail of reconciling items on the proportion sheet to the net income on the income instruction. As an accountant prepares the CFS using the indirect method, they can identify increases and decreases in the balance wheel sail that are the resultant role of non-cash transactions. It is utilitarian to see the affect and kinship that accounts on the remainder sail have to the net income on the income argument, and it can provide a better sympathy of the fiscal statements as a hale .

What Is Included in Cash and Cash Equivalents?

Cash and cash equivalents are consolidated into a individual course item on a company ‘s balance sheet. It reports the value of a business ’ randomness assets that are presently cash or can be converted into cash within a short period of time, normally 90 days. Cash and cash equivalents include currency, petit larceny cash, bank accounts, and other highly liquid, short-run investments. Examples of cash equivalents include commercial newspaper, Treasury bills, and short-run government bonds with a maturity of three months or less .

The Bottom Line

A cash run instruction is a valuable measure of strength, profitableness, and the long-run future lookout of a company. The CFS can help determine whether a caller has adequate fluidity or cash to pay its expenses. A company can use a CFS to predict future cash menstruation, which helps with budgeting matters .

For investors, the CFS reflects a company ’ s fiscal health, since typically the more cash that ’ s available for business operations, the better. however, this is not a inflexible rule. sometimes, a damaging cash menstruation results from a party ’ south growth scheme in the form of expanding its operations .

By studying the CFS, an investor can get a clear picture of how much cash a company generates and gain a solid understanding of the fiscal wellbeing of a party .

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Category : Finance

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