The cash flow statement (CFS), sometimes called the statement of cash flow, is a financial statement that shows how much cash comes into and goes out of a company during a given time period, such as a month, a quarter or a year. It includes cash and cash equivalents. Examples of cash equivalents are bank deposits, and short term investments and issues with maturities of less than three months.

Another financial statement, the income statement, recognizes sales when they’re made and expenses when they’re incurred, even if no cash has been received or paid out. Not so the cash flow statement. It cares only about dollars moving in and out of the business. For example, if goods are sold on credit, the income statement recognizes the sale as net income, but as far as the CFS is concerned, nothing changes until the customer actually pays the bill.

Cash is the lifeblood of a company, and the CFS tells you whether an organization is bringing in more cash than it is using. A healthy cash flow statements proves that a company is generating enough cash not only to cover current operating expenses by also to service debt and to make the capital expenditures it needs to ensure its long-term success.

The cash flow statements is one of the three most important financial statements, the others being the income statement (also known as the profit and loss statement, or P&L) and the balance sheet. The CFS has been mandatory for corporate reporting since 1987. Like the income statement, it reflects the company’s financial activity between one version of the balance sheet and the next. In fact, the net cash flow from the cash flow statement is equal to the difference in the balance sheets at the beginning and end of the accounting period. Unlike the income statement, the CFS emphasizes changes in cash and cash equivalents as opposed to differences in non-cash assets such as inventories and receivables.

There are three sections of cash flow in a CFS:

  • Operations, or operating activities, includes cash in and out from the day-to-day conduct of the business. Examples are sales, salaries, taxes and expenditures for supplies and raw materials.
  • Investing, or investing activities, shows what has been spent on long-term purchases such as equipment and real estate, what has been received from the sale of such assets.
  • Financing, or financing activities, focuses on the organization’s long-term fundraising activity. It shows income from loans or from sale of stock and also expenditures to repay loans.

The bottom line, net cash flow, is the summation of these three categories.

The Purpose of a Cash Flow Statement

A proper reading of the cash flow statement shows you whether a company is generating more cash that it’s using and how likely it is to bring in enough money to pay its operational costs plus service its debt and invest for the future. For example, if an organization is losing money in its day-to-day business and covering the loss by borrowing, that will be apparent in the CFS. You will also be able to tell if operations are just breaking even and the company is not able to make capital investments.

Beyond serving as a barometer for investors, creditors and others looking at the company from outside, the CFS is critical in giving the company owners and managers a concise and organized look at their cash flow situation. It can identify patterns and guide you in both short- and long-term decisions about spending. Not only does it tell you how much cash is coming and going, but it also shows what areas of concern might be. It can help plan and ensure you have enough cash on hand when bills, payroll and debt payments are due.

It’s not enough to know that you’re going to generate enough cash over the next year to meet all the year’s obligations. There can be peaks in expenses or valleys in income that threaten to compromise your cash position. You should run a cash flow statement at least once a month to spot any seasonal variations that might put you in a cash bind. If you’ve been having problems with cash flow, it’s a good idea to generate a CFS even more often, as frequently as weekly or even daily. The more often your statements, the better the detail with which you see your cash flow bumps and the better prepared you are to take action to get through them.

How To Read a Cash Flow Statement

The cash flow statement consists of a column of dollar figures showing changes in cash for a given period, be it a week, month, quarter or year. Sometimes there are multiple columns listing the figures for several sequential time periods. The three sections – operations, investing and financing – are displayed in order with line items and subtotals, and the bottom line is the net cash inflow or outflow for all company activities.

Operating Activities

There are two acceptable ways to report operating activities – the direct method and the indirect method. Either one results in the same operating activities subtotal.

In the direct method, you see all the sources of cash in and out and the total of them. These include inflows from sales and from accounts receivable being paid off and outflows for expenses such as payroll, payments to suppliers, insurance and taxes.

Though the direct method may be conceptually simpler, the indirect method is more often used. That’s because it ties more neatly to the income statement. It starts with net income and adjusts with all sources of income and expense that are not cash. For example, sales made but not yet paid for are receivables that count as income but do not involve the receipt of cash, and they need to be subtracted from income.

In the operating activities, under net income, you will see several adjustments, such as depreciation, increase in inventory, accounts receivable, accrued expenses and prepaid expenses. They are added to or subtracted from net income, giving a subtotal for net cash from operating activities.

This subtotal tells you how much cash the company had left over after paying for day-to-day operations. This number should be comfortably in the positive range. If there are more positive than negative adjustments to net income, and the net cash from operations is higher than net income, the company’s earnings are sometimes said to be “quality earnings.”

A healthy company generates enough cash to pay for all its current operations. If net cash from operations is small, or, worse yet, negative, it’s a huge red flag about the company’s ability to sustain itself as an ongoing business. It means that the organization is borrowing to pay its daily debts, and if that doesn’t change the business won’t be around for long.

Investment activities

While the operating activities report on cash flow around current assets and liabilities, the investment activities focus on the acquisition (and eventually disposal) of long-term assets. For many companies, there will be only two items under investments: cash spent for capital investments such as land and equipment, and cash received by divesting of those assets. Since companies pay more for new equipment that they recover when they retire it, investment activities usually are a cash outflow for a company and a negative number on the CFS.

Sometimes equipment and land will be listed separately in investment activities. While some accounting periods may report no investment expenditures, if a company goes year after year without these, its long-term prospects may be in question. A well-managed company should be investing for its future.

Financing Activities

This section covers the acquisition of outside financing, including loans, sale of stock and issuance of bonds. If any of those activities took place during the time period they will be reported here as cash inflows. Cash outflows include stock repurchase, dividends paid on bonds, retirement of bonds and loan repayments. Loan repayments always include reduction in principal and may or may not include interest paid. (Under generally accepted accounting principles (GAAP) loan interest is an operating expense, but it’s acceptable to include it in financing activities on a CFS.)

Net Cash Flow

The bottom line of the cash flow statement is the company’s overall cash flow including operations, investing and financing. While it’s good to see a strong positive number, a low number or even a negative one doesn’t necessarily mean that the company’s cash position is precarious. For example, a business that made large capital investments in land and equipment might have expended more cash that it received in that particular accounting period, but the fact that it made a major investment may bode well for its future. Also, a corporation that repurchased its own stock may have a low of negative cash flow for that period. It’s best to look at a series of CFSs over time to evaluate how well an organization is managing its cash.

How to Prepare a Cash Flow Statement

Preparing a cash flow statement may seem like a daunting desk, and many companies hire outside professionals to assist them. Whether you create the cash flow statement yourself or solicit the assistance of accounting services, the process is similar. You may prepare either a direct or an indirect cash flow statement. The two differ only in the operations activities; the investing and financing activities are identical whichever method you use.

Operating Activities

If you choose the direct method, you must gather all sources of cash inflow and outflow, including cash sales, payment of receivables, cash expenditures, cash payment of outstanding payables and cash prepayment of future expenses. You do not include depreciation or change in inventory. You simply list the inflow or outflow in each category and add and subtract them to get the subtotal for cash from operations.

For the indirect method, which most businesses use, the numbers tie directly to your income statement and the changes in the balance sheet from the beginning to the end of the period. To use this method, you start with net income and make adjustments.

The key to indirect method adjustments is this: Anything that increases net income but does not involve the movement of cash must be subtracted from net income, and anything that decreases net income but does not involve cash must be added to net income. Any cash in or out that does not affect net income must be added to or subtracted from net income.

These are the line items in a typical operations sections. Not all of them are present in every CFS, and some cash flow statements may have a few more.

  • Net income. Taken from the bottom line of the income statement. While this is the most commonly used figure for the top line of operating activities, it’s not the only one permitted. Some companies use operating profit or profit before or after tax. If you use a different starting point your adjustment will be slightly different.
  • Depreciation creates a decrease in net income but does not involve the outflow of cash. Therefore it needs to added to net income.
  • Increase in inventory. If your inventory increases, and cash was spent to do so, that cash outflow is not reflected in net income, so these expenditures must be subtracted. Note that this applies only to inventory that was purchased with cash and not to inventory bought on credit.
  • Change in accounts receivable. If your receivables have increased during the accounting period, your net income increased, but you didn’t receive cash. Therefore an increase in receivables must be subtracted from net income. Similarly, a decrease in accounts receivable must be added.
  • Changes in accounts payable and accrued expenses. These include expenses that were recognized in the current period but won’t involve the outflow of cash until a subsequent period. Examples can include payroll, taxes and inventory purchased on credit. If payables have increased, net income has decreased but there has been no cash outflow, so the increase must be added. Similarly, if payables have decreased the decrease must be subtracted. Sometimes different types of payables and accrued expenses are listed as separate line items.
  • Prepaid expenses. An example is prepaid insurance. These do not impact net income but involve a cash outflow, so must be subtracted in the operating activities.
  • Net cash from operations. The subtotal after you make all the additions and subtractions from net income. This is the amount of cash your business has left over after funding current expenses. It’s what’s available to build a reserve, pay long-term debts and make investment in the business’s future.

Some operations section include a few more items. One example is unearned revenue (goods or services you’ve been paid for in the current period but will deliver in a subsequent one), which was not included in net income so must be added. Another is stock-based compensation, which reduced net income without a cash outlay, and also must be added.

Investing Activities

For most companies, the most significant items in this section report the purchase of and disposal of long-term assets.

  • Purchase of property, plant and equipment (PP&E). These are the assets your company acquires as part of its long-term growth strategy. Cash paid for them is a subtraction from cash flow.
  • Sale of PP&E. When you eventually dispose of capital asset, the cash you receive adds to cash flow.

Both purchase and sale of PP&E may be divided into multiple line items by type of asset.

Also included in investing activities are the buying and selling of securities (other than you own company’s stocks and bonds) and loans made to vendors or received from customers. If cash moves in or out as part of a merger or acquisition, this goes in the investing section as well.

Financing Activities

This section focuses on activities related to long-term fundraising. It includes cash received in loans and the issue of stocks and bonds, and the outflow to repay loans or repurchase stock. Line items might include:

  • Additions to cash flow.

o    Loans received from banks and financial institutions.

o    Cash raised by issuing stock.

o    Cash received from an issue of bonds.

  • Subtractions from cash flow.

o    Repayment of loans.

o    Dividends.

o    Repurchase of stock.

Net Cash Flow

The bottom line, net cash flow for the accounting period, is derived by adjusting the net cash from operations with the investing and financing subtotals. In addition, some cash flow statements show the period’s beginning cash balance and ending cash balance. The cash flow is the difference between the two.

Cash Flow Statement Example

Here is a sample cash flow statement.

 

Twelve-Month Cash Flow                                                      [Company Name] Fiscal Year Begins:
Pre-Startup Estimate Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Total Item Estimate
Cash on Hand

(beginning of month)

Cash Receipts
Cash sales
Collections from CR accounts
Loan/ other cash
TOTAL CASH RECEIPTS
Total Cash Available (before cash out)
Cash Paid Out
Purchases (Merchandise)
Purchases (specify)
Gross wages (exact withdrawal)
Payroll expenses
Outside services
Supplies
Repairs & maintenance
Advertising
Car, delivery, travel
Accounting & legal
Rent
Telephone
Utilities
Insurance
Taxes
Interest
Misc.
SUBTOTAL
Loan principal payment
Capital purchase
Other startup costs
Reserve and/or escrow
Owners’ withdrawal
TOTAL CASH PAID OUT
Cash Position (end of month)
ESSENTIAL OPERATION DATA (non cash flow information)
Sales volume (dollars)
Accounts receivable
Bad debt (end of month)
Inventory on hand (end of month)
Accounts payable (end of month)
Depreciation

In summary, the major financial documents, the income statement, the balance sheet and the cash flow statement, are the company’s report card. They measure its stability and profitability and speak to its long-term outlook. The help the company’s managers predict future cash flow and be accurate in their budgeting. A careful reading of CFS tells you a lot about how well the organization is managed and what its prospects are.