The Cash Flow Statement

What is the Cash Flow Statement?

The cash flow statement is one of the “go to” documents showing a company’s health of operations. In a nutshell, it shows if a company is gaining cash, losing cash, and where their cash going.  It is the reconciliation of net profit and the net profit’s effect on the balance sheet.  Below are some brief comments on the sections of a proper cash flow statement. There are two ways to create a cash flow statement, the direct method and the indirect method.  The direct method is more simple as it tracks the specific movement of cash in and out as related to operating activities.  The indirect method is more complicated and factors in depreciation and other non-cash activities.  The differences between the two methods is in the first section of the cash flow statement.  Nearly all corporations utilize the indirect method.

Cash From (Used) in Operating Activities:

The first section of a cash flow statement should show how the company’s operations effected its cash and cash equivalents and would normally be called “Cash From (Used) in Operating Activities.”  Using the indirect method, this section starts by adjusting Net Profit to Net Cash by adjusting net profit for the non-cash effects on operating income.  An example would be a company having a large amount of credit sales (increasing their net income) but those sales would not add to the cash balance (unless the cash had been collected by the close of the period,) hence an adjustment must be made.  Ideally operations should be providing cash to cover all operational needs and adding to the net cash balance of the company.  It is important to review more than one month at a time as a large increase in accounts receivable or a large decrease accounts payable can result in a negative cash contribution from operations.  If accounts receivable continues to show increases from month to month, it could indicate an issue in collecting outstanding receivables.  It could also indicate a continuous increase in overall sales for the company.  Also look at the inventory change, a large increase or decrease can signify an issue with inventory management.  Many companies have seasonal swings in operations, which also need to be taken into account.  Over the longer term, operations should be providing the cash to operate the company, pay down debt, replace old equipment, fund growth as well as pay the owners a dividend.

Cash From (Used) by Investing Activites:

The second part of a cash flow statement displays the effects of the company’s investing activities, this is normally called “Cash From (Used) by Investing Activities”.  We are discussing what a company is investing in their future such as fixed assets, investment activities, or loan activity to other entities. We are not discussing the owner’s investments in the company.  Here the company is purchasing assets to replace worn and obsolete equipment to keep its’ technology current.  There are some that believe a thriving company should be reinvesting in itself an amount equal to its depreciation expense. However this would not be the case with a service company, which typically would not have a large investment in fixed assets.

Cash From (used) by Financing Activities:                                              

The third section of a cash flow statement shows what extent a company is dependent on outside financing.  This is where you would see payments or borrowings to a lender, investments from owners, and payments to shareholders.  Over time this section will show if a company is a net borrower, in essence borrowing more than it is paying off, or if it is meeting its’ financial obligations.

The final information on the cash flow statement shows the beginning cash balance of the period reconciled to the ending cash balance using the summary of the net changes in cash from the three sections.  Companies are also required by GAAP and IFRS to disclose significant non-cash financing or investing activities as a footnote at the end of the cash flow statement or in the notes to the financial statements.

The Cash Flow Statement is a crucial financial instrument in showing the health of a company. Like the Balance Sheet and Income Statement, it is an important management tool for the business owner. A company should always have an experienced and qualified financial expert reviewing and reporting on all of its financial statements.

A B2B CFO® partner is an experienced expert and can assist the business owner in putting together and interpreting a cash flow statement and other important management tools. 

Taryl Enderson, Partner


photo credit: Asian Development Bank General Photos – ADB Headquarters, Philippines via photopin (license)

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