What is a Cash Flow Statement? (With Examples)

A company uses cash flow statements to determine the inflow and outflow of cash during a particular accounting period. Cash flow statements include details about operations, investing and financing. Accountants have multiple means (indirect and direct) to determine cash flow, depending on the size of the business.

Companies have several instruments at their disposal to help measure their success. Accounting departments at organizations of all sizes create detailed documents to illustrate their financial performance. One of these documents, the cash flow statement, shows businesses how money comes in and out of the company.

What is a Cash Flow Statement?

Cash flow statements display sources of cash and help companies monitor incoming and outgoing funds. They are one of the three main reports that provide a picture of a company’s overall performance. Other tools companies use include income statements and balance sheets.?

Why is a Cash Flow Statement Important?

Cash flow statements illustrate essential information about a company’s financial health. Businesses need sufficient cash to cover expenses, including bank loans and potential investments. Cash flow statements provide several benefits to businesses. They can:

• Provide detailed spending information.
• Help companies find cash-generating opportunities.
• Help maintain an appropriate cash balance.
• Help create short-term plans.

Spending Information

Companies use cash flow statements to break down payments they make to creditors. They also include inventory purchases, capital spent on equipment and credit extended to customers.

Cash Generation

While profits are important for generating cash, they are far from the only method a company uses. Companies that pay less than expected for equipment or collect receivables from customers faster than usual are gathering cash, for example.

Cash Balance Maintenance

Cash flow statements allow a business to maintain an optimum cash balance. A company with either too much cash sitting idle or a shortage of funds may not be using its cash efficiently. Cash flow statements help businesses understand where money is going and when to look for borrowing opportunities.

Short-term Planning

Cash flow reports are valuable tools for short-term planning. Businesses with insufficient liquid cash cannot fulfill their short-term obligations. Financial managers or controllers can look at the cash flow statement to make decisions, such as requesting credit from banks or paying off debts.

Format of a Cash Flow Statement

Cash flow statements contain three distinct sections. Each section outlines different information about activities driving cash flow within the company. They are as follows:

Operating Activities

Cash from operating activities includes receipts from the sale of goods or services. The other components that make up this section of the report include:

• Interest payments.
• Income tax payments.
• Payments made to suppliers.
• Salary and wage payments.
• Rent payments.
• Other operating expenses.

Investing Activities

Cash flow from investing activities includes sources or uses of cash from investments. This means any payment toward a merger or acquisition or from the purchase or sale of assets.?

Financing Activities

Cash flow from financing activities describes the use of cash paid to shareholders or sources of cash from investors and banks. It also includes any dividend payments, stock repurchases or the repayment of any debt principal.

How to Calculate Cash Flow

Companies have two methods at their disposal for calculating cash flow: the direct and indirect methods.

Direct Cash Flow Method

Large businesses prefer the direct method of determining cash flow. Through this process, a company records all cash transactions to display that information using inflows and outflows for a specific accounting period. Elements of a direct cash flow statement can include:

• Salaries.
• Vendor or supplier payments.
• Customer payments.
• Interest income.
• Dividends received.
• Paid income taxes and interest.

Indirect Cash Flow Method

Small- and medium-sized businesses favor the indirect method because it is simple. In this method, a company starts with the net income over a given period and makes adjustments or changes to determine cash on hand.

Example of a Cash Flow Statement

How to Analyze a Cash Flow Statement

After preparing a cash flow statement, companies look at trends or outliers to determine their business’s health. Essential questions to ask regarding the cash flow statement include:

• Does the business have positive or negative cash flow?
• Why does the business have negative cash flow?
• Why does the business have positive cash flow?

Negative cash flow is not necessarily always a bad thing. A business that builds cash reserves and reinvests those funds into equipment or facilities will often show negative cash flow for a given year. If those investments help grow the business over the next few years, it might be worth it.

Positive cash flow, on the other hand, might not be good. Imagine that a business must take on debt to provide working capital and pay its bills. The cash flow from financing activities will show positive cash flow, but at the cost of additional debt.

Cash Flow Statement vs. Income Statement

Cash flow statements differ from income statements. The income statement gives the reader a business’s revenue and gains, but they also show expenses and losses. The company then uses this information to determine income-related figures.

Cash Flow vs. Profit

Cash flow does not equal profit. While cash flow describes money that flows in and out, a company calculates profit by deducting costs from revenue. Profit might show a business’s immediate success, but cash flow can better describe long-term prospects. Companies can be profitable even with poor cash flow.

Final Thoughts

Companies and their investors always need to have a handle on their cash flow. It is an essential tool to help guide decision-making and understand business performance. Even if companies outsource these reports, they should have a dedicated staff member who understands how to analyze them and prepare solutions to concerns that they uncover.

Top Takeaways

• Cash flow statements are one of the three main reports businesses use. Other tools companies often use are income statements and balance sheets.
• Cash flow statements contain information about cash that flows in and out via operations, investments and financing.
• Companies use two methods to determine cash flow: indirect and direct.
• Cash flow is different from both income and profits.

(Reporting by NPD)