Cash Flow Statement

Denise Elizabeth P
Senior Financial Editor & Contributor

A business needs cash to keep itself running, and any business owner would want to keep track of their cash.

The cash flow statement is the perfect tool for that purpose.

It’s one of the three main financial statements, the other two being the balance sheet, and the income statement.

Its main purpose is to provide us with information about the inflows and outflows in the cash and cash equivalents of a company.

All companies that publicly sell and offer stocks are required by the Securities and Exchange Commission (SEC) to prepare and file financial reports and financial statements, one of which is the cash flow statement.

But even if you’re not a publicly listed company, preparing a cash flow statement would still be advantageous for you.

Cash flow statement

The cash flow statement: what is it?

As previously stated, the cash flow statement’s main purpose is to provide us with information about the inflows and outflows in the cash and cash equivalents of a company during a specific period.

It includes inflow/outflows from operating, financing, or investing activities.

It provides us with a more in-depth view of a company’s cash that the balance sheet and income statement can’t provide.

According to IAS (International Accounting Standard) 7, a cash flow statement consists of three sections:

  • Operating Activities
  • Investing Activities
  • Financing Activities

By categorizing each cash flow into these three sections, we can properly identify by which way a company is gaining or spending its cash.

A huge increase in cash does not always mean a huge profit after all.

The increase could be because a company was able to secure a huge loan agreement or sell a high value fixed asset with no profit.

These transactions generate cash, but they don’t immediately produce profit for the company.

A cash flow statement is a great tool for management for assessing the handling of the company’s cash.

A company may be profitable, but it may also be poor in the management of its cash.

For example, let’s say a lot of customers sought the services of company A, to which company A delivered.

However, only 50% of these customers have paid for the year.

This could mean that the company isn’t as efficient in collecting its cash as it should be.

operating activities cash flow

Operating Activities

The first section of a cash flow statement is the Operating Activities (or Cash Flows from Operations).

This section includes all cash inflow and outflows from a company’s operations such as cash received as payment for goods and/or services, cash spent on operating expenses, payments made to suppliers, etc.

Depending on method the employed by the company, the presentation and calculation of this section will differ (the two methods of preparing a cash flow statement will be discussed later in this article).

The Operating Activities section can tell us how efficient a company is earning in terms of cash.

A positive net cash flow from operating activities could mean that on top of generating revenue, the company is efficient in collecting its account receivables.

Or it could be that the company is effective in converting its inventory into cash.

However, management can also ‘cheat’ the Operating Activities sections in that it could deliberately delay its cash outflows to present a more favorable cash flow statement.

For example, management may delay or extend payments to the company’s suppliers.

In cases like this, it’s advisable to also look at the company’s balance statement and income statement.

A high expense figure in the income statement or high accounts payable in the balance sheet but low cash outflow in operating activities may mean that management is deliberately delaying its cash payments for a more presentable net cash flow from operating activities.

Investing Activities

The second section of a cash flow statement is the Investing Activities section (or Cash Flow from Investing).

This section includes all cash inflows and outflows involving long-term assets such as land, building, equipment, machinery, etc.

It also includes other assets that cannot be considered as cash equivalents such as the shares of another company.

This is the section to look at for movements in a company’s capital expenditure (CAPEX).

The purchase of a long-term asset would result in a cash outflow in the Investing Activities section.

Purchasing stocks of another company treated to be an investment would also yield the same result. In general, any cash used for investments would be tagged as cash outflow under this section.

The most common way to generate cash inflow in the Investing Activities section is to sell a company’s long-term assets.

Any cash generated from such a sale will be categorized as a cash inflow under this section.

Another way of generating cash inflow under this section is by receiving dividends from the shares that a company has invested in.

A negative net cash flow from investing activities isn’t necessarily a bad thing for a company.

It could mean that the company is building up its capital assets, or it’s allocating most of its cash for assets that can generate profits in the future. In most cases, companies that are still growing will have a negative net cash flow from investing activities.

Financing Activities

The third and final section of a cash flow statement is the Financing Activities section (or Cash Flows from Financing).

It includes any cash inflows and outflow that affect the equity capital and borrowing structure of a company. Cash received or paid to owners and creditors fall under this section.

Receiving cash through a loan, or issuance of new shares will generate cash inflow in the Financing Activities section.

Meanwhile, the payment of loans or dividends will result in a cash outflow.

The purchase of already issued stocks (to be recognized as treasury stocks) will also result in cash outflow, provided such purchase is made with cash.

A positive or a negative net cash flow from financing activities does not necessarily relate to a company’s profitability. I

t just shows us how a company finances itself outside of operations and investments.

A positive net cash flow under this section means that the company is receiving more cash than it is spending through financing.

A negative net cash flow would mean the opposite.

Preparing a cash flow statement: Direct Method vs Indirect Method

A company may present its cash flow statement in two ways: the direct method, and the indirect method.

IAS 7 encourages the use of the direct method, but it does not prohibit the use of the indirect method.

Which method a company uses may depend on the accounting method it’s employing.

The direct method is most advantageous for companies that use the cash accounting method.

As its name implies, it directly provides us with all the inflows and outflows of cash, such as cash received from customers, cash paid to suppliers, cash spent on operating expenses, etc.

Since companies that use the cash accounting method only record transactions whenever cash is involved, it should be easier for them to prepare cash flow statements using the direct method.

Here’s a sample cash flow statement that uses the direct method:

Sample Cash Flow Statement

As can be seen from above, ML company has a net cash flow of $17,010 for the year ended December 31, 2020.

It generated a net cash inflow of $10,010 from its operations, while it spent more on its investing activities which created a net cash outflow of $38,000.

It was able to generate a net cash inflow of $45,000 from its financing activities, which all in all resulted in a net cash inflow of $17,010.

The indirect method is a little bit more complicated than the direct method.

It uses the changes in some balance sheet items (current assets except cash, and most current liabilities) to compute a company’s net cash flow from operating activities.

Companies that use the accrual accounting method usually prepare their cash flow statements using the indirect method.

The indirect method begins with a company’s net income from its income statement, and from there adds or subtracts certain amounts to arrive at the net cash flow from operating cash flows.

For example, non-cash expenses such as depreciation and amortization are added back to the net income since these are expenses that didn’t result in a reduction of cash.

In general, an increase in a company’s current assets (except cash and cash equivalents) would result in a cash outflow, while a decrease would result in cash inflow.

For example, a company’s inventory beginning balance is $1,250, while its ending balance is $1,000, resulting in a decrease of $250.

Under the indirect method, this would be tagged as a cash inflow in the Operating Activities section of the cash flow statement.

The principle here is that a reduction in the inventory means that the company was able to convert it to cash.

As for liabilities, the reverse is true.

An increase in current liabilities would result in a cash inflow, while a decrease would result in cash outflow.

For example, a company’s accounts payable beginning balance is $800, while its ending balance is $500, resulting in a decrease of $300.

Under the indirect method, this would be a cash outflow under the Operating Activities section.

It could mean that the company paid more cash to settle its accounts payable.

To understand this method further, here is an illustration:

cash flow

Can you see the difference in the presentation when compared to the direct method?

While the Investing Activities and Financing Activities sections are similar between the two methods, there is a huge difference in the Operating Activities section.

Instead of directly listing down the cash inflows and outflows from operating activities, what we see are very different line items.

It started with the net income, and then made additions and subtractions to come up with the net cash flow from operating activities.

While the indirect method is easier to use for companies who use the accrual accounting method, it doesn’t mean that they can’t use the direct method.

The direct method is much more basic and easier to understand, which makes it extra useful to those not well-versed in accounting.

Uses of the Cash Flow Statement

The balance statement gives us an idea of a company’s financial position.

The income statement provides us with information regarding a company’s ability to generate profit. So what does the cash flow statement do?

As its name implies, the cash flow statement shows us a company’s cash flow.

Business owners can use it to see how their business handles their cash.

Management uses it to properly manage their budget, identify which department or unit is cash-intensive, and make decisions on cash matters.

Creditors use it to assess a company’s ability to pay in cash.

Investors can use it to understand whether a company is worth investing in.

A company with a positive net cash flow, especially if it came from operating activities, usually attracts would-be investors.

The cash flow statement is a very useful tool for any business.

It shows us if a business is raking in or losing cash over time.

Since cash is essential in keeping a business operational, knowing when cash is going in or out can be critical.

If the business is bleeding out cash, you would want to know how to stop the bleeding.

The cash flow statement can aid you with that.

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  1. "International Accounting Standard 7" White paper. August 17, 2021

  2. "Form 1120" Page 1 . August 17, 2021

  3. "Business Insights" Page 1 . August 17, 2021