What is a Cash Flow Statement?
The cash flow statement is a financial statement that summarises the cash and cash equivalents entering and leaving a company. It helps you measure a company's cash position. For example, how well it generates cash to pay its creditors and fund its operating expenses.
The cash flow statement complements the balance sheet and income statement and is a mandatory part of a company's financial reports.
How does a Cash Flow Statement Work?
A cash flow statement works by tracking the cash a business receives and pays through operating, investing, and financing activities. Unlike net income, it excludes non-cash items such as depreciation and amortisation, giving a clearer view of the company’s actual cash position.
Cash flow from operating activities is generally calculated according to the following formula:
Cash Flows from Operations = Net income + Noncash Expenses + Changes in Working Capital
Even profitable, well-organised firms can fail to manage their cash flow well, which can affect their financial health later. Keeping a close eye on your working capital solves half your cash flow problems. It gives you a clear picture of your receivables and payables.
For example, accounts receivable is a non-cash account. If accounts receivable goes 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 isn't cash. Operating activities can also include accounts payable, depreciation, amortisation, and prepaid items booked as revenue or expenses with no associated cash flow.
Cash flow from investing activities mainly reflects a company's purchases or sales of capital assets (assets with a useful life of more than one year that appear on the balance sheet). Companies have some leeway in deciding what counts as a capital expenditure, so investors should keep this in mind when comparing cash flow across different companies.
Cash flow from financing activities typically reflects a company's purchase or sale of stock, and any proceeds from or payments on debt financing. This measure varies with a company's capital structure, dividend policy, and debt terms.
Why do Cash Flow Statements matter?
Cash flow statements offer several benefits when maintained diligently and regularly. Beyond showing you cash inflow and outflow, they help companies expand, develop new products, buy back stock, pay dividends, or reduce debt.
Cash flow statements also show you how successful your business is in terms of growth. You can evaluate your goals, plan your company's future, and assess the liquidity risks you might run into.
Negative cash flow for a period isn't always a bad thing. For example, if a company is a net spender of cash because it's building a second manufacturing plant, this could pay off if the plant generates more cash later. But if the negative cash flow comes from a poor acquisition or investment, the long-term benefit might not follow.
