Simply Finance: The Cashflow Statement

What is the Statement of Cashflow?

The Statement of Cashflow is one of the three primary financial statements, and it reports and deals with changes in cash within a business period (i.e., a month, quarter, or year). It is a powerful instrument to identify sources (inflows) and uses (outflows) of cash. As such, it is most useful to evaluate companies using Discounted Free Cashflow (DFC) and Adjusted Present Value (APV) analysis. 

The Cash Flow includes three main sections: 

  • Cashflow from Operating Activities
  • Cashflow from Investing Activities
  • Cashflow from Financing Activities

What is Cashflow important?

When netting revenues with expenses and working down to the bottom line of the Income Statement, investors get to examine a company’s earnings. Nonetheless, Net Income does not necessarily equal cash flow. The reason being accrual accounting. 

Accrual accounting is one of two accounting methods (the other being cash accounting). Under this method, a firm recognizes revenue when it sells goods or renders services regardless of when cash transactions occur. For example, say company XYZ is a retailer and has 100 customers. 10 of these customers go to buy product A at the store, but they buy on credit. At this point, XYZ recognizes revenue, but it receives no cash. 

Although it makes sense for companies to use accrual accounting, the same is not necessarily true in finance. After all, cash is king. Investors care about when cash comes into or leaves a company. It is what they make a profit from.

The Statement of Cashflow resolves this problem, as it is based on cash accounting. Through this method, firms measure performance from selling goods and providing services as they receive cash from customers, and investors get what they want.

Cashflow from Operating Activities

This is the first segment of the cash flow statement, and it includes the principal revenue-generating activities of a company. Mainly, it reports cash inflows and outflows originating from any business-related activity, such as sales, purchases, and other expenses. 

The CFO is responsible for choosing between two different methods to present operating cash flow: 

  • The Direct Method is the least common between the two. It involves listing each major class of cash receipts transactions. It might include Cash Received from Customer, Cash Paid for Merchandise, Cash Paid to Suppliers, and cash Paid to Employees. 
  • The Indirect Method begins with Net Income. However, as mentioned before, Net Income is determined using accrual accounting, and it must be adjusted for revenues and expenses that do not affect cash. In short, we have to reconcile all non-cash items involving operational activities to cash items. 

Cashflow from Investing Activities

This is the second segment of the cash flow statement, and it is the result of investment gains and losses. It includes the purchase and sale of non-current (or fixed) assets and other investments. Typically,  Cashflow from Investing Activities is linked with the acquisition cost or sale gain from PP&E (Property, Property, and Equipment), namely Capex (Capital Expenditures). 

Although positive cashflow in this section is not a negative sign, investors usually prefer to see large investments in fixed assets such as PP&E. Negative cashflow represents a promise to future economic benefits and growth, and investors like it. 

Cashflow from Financing Activities

This is the third and last segment of the Cashflow Statement, and it is used to report cash inflows and outflows used in business financing. Financing activities relate primarily to changes during the year in non-operating liabilities (such as bonds payable) and in stockholders’ equity. After all, there are only two main ways of financing a company: issuing debt or equity. 

Cashflow from Financing Activities is usually associated with borrowing or repaying loans, and issuing or buying back shares. Finally, in this section, dividends are also accounted for, as they are cash outflow to investors and equity owners.


In a Nutshell

Simply Finance: the Cashflow Statements summary

Test yourself!

Public companies usually publish their financial statments on a quarterly and annual basis. You can find  US-based public company’s balance sheets on the US Securities and Exchange Commission (SEC) website. Search for the 10-K, and you will be ready to go!

Written by

Cheryl Toh

Last updated on

August 21st 2019, 6:05 pm

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