The cash flow statement is a financial statement that shows how cash inflows and cash outflows affect a company's cash position in an accounting period. Learn the definitions, key concepts, how to prepare the statement, and the right way to analyze the numbers.
The statement has three main categories: cash flow operating activities (CFO), cash flow from investing activities (CFI), and cash flow from financing activities (CFF).
The result of each category could be positive (cash inflow) or negative (cash outflow). And, at the bottom of the statement, each number is added together to reach the total change in cash position for the period.
Common size analysis can be performed on the cash flow statement in order to compare firms of different sizes or the same company over multiple periods in time. The common size cash flow statement reports each line item as a percent of revenue.
This can be particularly helpful when forecasting future cash flow, as you can build a forward-looking cash flow statement once you understand your revenue projections.
The cash flow statement follows a standard format. Here is the basic template of a cash flow statement:
As a general rule, operating activities relate to a company’s current assets and current liabilities, investing activities relate to a company’s non-current assets (also called fixed assets), and financing activities relate to a company’s non-current liabilities (also called long term liabilities) and shareholders’ equity.
This does not hold true always, but is a good starting point when thinking about the statement of cash flows.
The cash flow statement lists the necessary transactions to reconcile between the company’s accrual accounting and their actual cash flows of the business.
Cash flow from operating activities (CFO) refers to transactions that happen during the ordinary course of business. You can think of cash flow from operations as all activities that directly impact net income.
For example, a retail store might purchase additional inventory, which increases current assets and reduces operating cash flow. This is recorded as a cash outflow for CFO because cash was used to purchase inventory.
If the company turns around and sells those goods on credit, that would reduce operating cash flow as well. Accounts receivable (a current asset) would increase and the inventory would be sold, but no cash is collected, which harms cash flow.
In another example, the retail shop might see an increase in accounts payable (a current liability), which is considered a cash inflow for CFO because more cash was kept in the business.
In general, cash collected from customers is a cash inflow from operating activities and items such as cash paid to vendors, suppliers, employees, or other expenses are cash outflows from operating activities. Interest payments and dividends received are a cash inflow from operations, while interest payments and dividends paid are a cash outflow.
Here is a list of operating activity examples:
Cash flow from investing activities (CFI) shows changes to the company’s long-term assets and certain investments held by the company. Note, these are not investments made into the company; these are investments the company holds.
A company generates positive cash flow from investing by selling a fixed asset, selling investments, or receiving principal from loans extended to other businesses. By contrast, a company generates negative cash flow from investing by acquiring fixed assets, acquiring debt or equity instruments, or making loans to other businesses.
Here is a list of investing activity examples:
Cash flow from financing activities (CFF) shows changes to the company’s capital structure. This section records the two ways of financing a business, through debt and through equity.
Companies raise money by taking on debt or issuing equity. Both of these are cash inflows to the business. Receiving a loan generates cash and increases total liabilities, while issuing stock generates cash and increases your total shareholders’ equity.
On the other hand, a company will use cash to pay off the principal amount of its debt, reacquire stock from the market, and pay dividends out to shareholders.
Here is a list of investing activity examples:
When using the indirect method, it’s helpful to remember that:
This is because cash is used to purchase an asset and cash is generated when an asset is sold. Also, liabilities only increase when a company takes on debt or has an obligation to make future cash payments.
Increasing liabilities will increase a company’s cash position in the near term. The opposite happens when liabilities decrease.
As a note, the direct method starts with revenue, which is at the top of the income statement while the indirect method starts with net income, which is the bottom line of the income statement.
Under U.S. Generally Accepted Accounting Principles (GAAP), companies that report using the direct method must also provide the adjustments needed to convert net income to cash flow from operations (CFO).
Now that we have covered all of the key topics, we will walk through a cash flow statement example together. This example uses the indirect method, starting with net income.
Net Income: $300,000
Adjustments for depreciation: $25,000
Adjustments for amortization: $30,000
Adjustments for increase in inventories: -$75,000
Adjustments for increase in accounts receivable: $15,000
Net Cash Flow from Operations: $295,000
Cash generated from fixed asset sale: $50,000
Cash paid for fixed asset acquisition: $150,000
Net Cash Flow from Investing: -$100,000
Cash paid for loan repayment: -$100,000
Cash generated from common stock sale: $250,000
Net Cash Flow from Financing: $150,000
Net Cash Increase for Period: $295,000 -$100,000 + $150,000 = $345,000
Cash at Beginning of Period: $200,000
Cash at End of Period: $545,000
Now that we have walked through this example, let’s discuss each section in a little more detail. First, we started with net income and added back the non cash activities (depreciation and amortization). Next, we looked at our current assets and current liabilities.
In this case, inventory had increased which is a user of cash and accounts receivable decreased which means we collected more cash in the period. The net CFO for the fiscal year 2021 was $295,000. Keep in mind that cash flow from operations usually has the most adjustments.
For cash flow from investing activities, there were only two changes to fixed assets. The company disposed of $50,000 of fixed assets and purchased $150,000 of new fixed assets. The net CFI for the fiscal year 2021 was -$100,000, meaning that the investing activities were consumers of cash in 2021.
For cash flow from financing activities, there were again two changes to record. The company repaid a $100,000 principal on a loan. (Remember that principal repayments are CFF while interest payments are CFO.) In order to fund the loan repayment and the asset purchases, the company sold common stock in exchange for $250,000 of cash.
The company entered 2021 with a cash balance of $200,000, added $345,000 to the bank balance throughout the year, and ended up with a balance of $545,000.
The cash flow statement does not have its own transactions. Instead, line items on the statement of cash flows come from income statement line items or balance sheet accounts.
Statement of Cash Flows Key Takeaways:
Moreover, there are two ways of creating a cash flow statement – the direct and indirect methods. The direct method starts with revenue (top of the income statement) and makes adjustments for each line item to reflect the actual cash that changed hands.
By contrast, the indirect method starts with net income (bottom of the income statement) and converts that value into operating cash flow.
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