A Cash Flow Statement (CFS) is a financial statement that indicates the amount of money a company has generated and spent over a particular period of time.
It measures the company’s general financial performance and stability.
A cash flow statement is among the three financial statements prepared by a business at the end of every accounting process. It allows the company to know the amount of money that moves in and out of the company. The cash flow statement can be used to indicate the financial activities of a business on a monthly, quarterly, or yearly basis.
It is not only used by companies to measure their financial stability but is also used by other parties related to the company. These third parties can review and evaluate the financial position of the business using their cash flow statement.
For instance, the cash flow statement is important to creditors. Creditors can use the statement to determine how much money the company spends while funding its operations. Also, this statement can show creditors how well the company can pay its bills and debts and if the business is financially stable.
Additionally, the cash flow statement can be used by potential investors to check the financial status and stability of the company. It allows the investors to understand how the company gets its money and how it is spent, influencing investors’ decisions to work with the company.
Difference B/W a Balance Sheet & Cash Flow Statement
In most cases, the total amount of money available on the company’s account is always evident on the balance sheet. At the same time, a cash flow statement offers evidence of what a company generates and spends.
Below are some of the key factors that help to differentiate a balance sheet and a cash flow statement:
Changes in working capital
Working capital is any asset(s) owned by the company. Any decrease in the current company’s assets, besides money, increases the company’s cash, while an increase in the current company’s assets decreases the company’s cash.
It is necessary to indicate such changes in the company’s cash flow statement. Also, it is important to note that any increase in an existing liability increases the company’s money. In contrast, a decrease in any present liability decreases the cash in the company’s accounts.
Investments
It is important to indicate any investments made by the company in the cash flow statement. This is because whenever the company indulges in temporary financial investments or invests in fixed assets like properties, the company’s cash account drops. However, when the company sells any of its investments, then the cash is increased.
Net income before preferred dividends
Net income basically means that there is more cash in the bank. This statement is normally deducted from the income statement(s). In most cases, the net income decreases whenever the company orders stocks in which they have to pay dividends.
Securities transactions and dividends
Whenever the company pays its dividends to investors, the cash drops. The cash also decreases anytime they pay off their debts or buy back their stocks. However, it increases when they sell stocks or bonds. This information should also be indicated in the cash flow statement.
Non-cash adjustments to the net income
The company can calculate the flow of its money by adding back any non-cash expenditure, for instance, devaluations or depreciation and repayments. This allows the business to have a clear picture of the total amount of cash they have in their accounts.
Components of a Cash Flow Statement
When preparing a cash flow statement, the company should ensure that the following components are included in the statement.
To understand how essential these components are in a cash flow statement, here is an example of a cash flow statement template a company may prepare:
| Item | Increase or Decrease |
| Operating cash flow | |
| Net Income | (Amount) |
| Depreciation | (Amount) |
| Current Assets (Cash inflow and added to net income) | (Amount) |
| Current Liabilities (Cash outflows subtracted from net income) | (Amount) |
| Net cash from Operations | (Amount) |
| Investing cash flow | |
| Selling assets or investments (Cash inflow) | (Amount) |
| Buying assets or investments(Cash outflow) | (Amount) |
| Net cash from Investing | (Amount) |
| Financing cash flow | |
| Loan payment (Cash outflow) | (Amount) |
| Payment of dividends to shareholders (Cash outflow) | (Amount) |
| Net cash from Financing | (Amount) |
| Net Increase or Decrease in Company’s Cash | Calculated by adding up all the three-section if the financing cash flow is a positive change like selling shares or Calculated by adding operating cash flow and investing cash flows then subtracting financing cash flow from the total if it is a negative change like paying loans. |
Operating cash flow
A company needs to have enough cash to sustain and ensure that the business operations are running smoothly. This is referred to as the operating cash flow. In other words, operating cash flow is the money set aside so that the company can make purchases, make sales, pay debts, and any other expense the business incurs.
The operating activities that bring about the operating cash flow include all cash flows arising from current assets and liabilities. Current assets contribute to cash inflows, while current liabilities contribute to cash outflows.
This means that if an asset is sold, there is an increase in company cash inflow compared to when another asset is bought when the company is investing. The assets will reduce if one asset is sold but the money being received by the company will increase.
For current liabilities, if liability is paid, then the cash outflow from the company increases, and the items in liability are reduced. If there is no increased cash outflow from the company, it means that no liability has been paid or even more items have increased in the current liability since the company’s cash has been saved instead.
Note: The operating, investing, and financial cash flow are presented using two methods, direct and indirect methods, which will be discussed later on in the article.
Investing cash flow
Any established company has several investments that bring in extra income. Investing cash flow means the money used by the company to acquire or dispose of properties, plants, or equipment (PP&E). Therefore, the cash flow generated from investments mostly includes selling and acquiring assets (non-current) that are not included in the company’s cash calculations.
To calculate the cash flow received from investing activities, the company should add up all the cash inflow (usually from selling assets or assets maturing) and subtract the cash outflows (usually from buying assets or newly fixed investments).
For investing cash flow, the company can derive the investing cash from either cash inflow or cash outflow activities.
Examples of cash inflow activities include selling investments, machines, land, goods, and otter different properties. Cash outflow activities related to investing cash flow include buying assets, buying shares, buying government bonds, and even giving loans to other parties.
Financing cash flow
Financing cash flow is a statement that indicates the company’s money used to support and fund the business. Financing cash flow is the money used by the business to sell or buy back shares, apply for loans, pay dividends, and pay back debts or bank loans.
The financing activities of a company include any cash that is either paid or received to fund the company’s operations but is not included in the investment cash flow. It is all about raising capital or cash to pay back investors, loans, or debts and buying back shares.
They include activities related to the shareholder’s capital like paying them dividends and any long-term or non-current liabilities like paying government bonds or loans taken when starting the company. Financing activities usually involve mostly cash outflows, but a few activities are responsible for cash inflows, like selling the company’s stock or receiving government bonds.
Note: When preparing the cash flow statement, it is important to include the disclosure of non-cash activities according to the General Accepted Accounting Principles (GAAP).
Preparing a Cash Flow Statement
Below are the two main approaches a company can use when preparing a cash flow statement:
Direct cash flow method
The direct cash flow method is mostly suitable for small businesses. This method is considered straightforward because it adds up all the payments received and spent by the company. The direct cash flow method may include money paid out to salaries, money released to suppliers, and cash received from clients. All the receipts received during such transactions are used to prepare the cash flow statement. The direct method also accounts for other cash payments from the company like paying taxes, interests, and other expenses.
With the direct cash flow method, the company can easily know the exact and actual cash inflows and outflows. The method indicates all the cash inflows and outflows as they happen for better financial records and calculations. Unlike the indirect method, the direct method is based on cash accounting, that is, taking account of all cash receipts for inflows and cash payments for outflows.
Another way to make calculations using the direct cash method is by subtracting the ending and starting balances of different assets and liabilities to determine the net increase or decrease in a direct way.
Here is an example of a cash flow statement that uses the direct cash flow method:
Direct Method Example
| Operating Activities | |
| Cash payment to suppliers | (Amount) |
| Cash from customers | (Amount) |
| Net Cash from Operating Activities | Total Amount |
| Investing Activities | |
| Buying machines | (Amount) |
| Selling land | (Amount) |
| Net Cash from Investing Activities | Total Amount |
| Financing Activities | |
| Dividends payment to investors | (Amount) |
| Loan payment | (Amount) |
| Net Cash from Financing Activities | Total Amount |
| Beginning Cash Balance | (Amount) |
| Ending Cash Balance | (Amount) |
These activities will help the company determine whether it is a cash inflow that should be added or a cash outflow that is subtracted.
Indirect cash flow method
The indirect cash flow method reconciles money used by the company starting from the net profit made to the money used to fund the company or cash flow. With this method, a company can identify any increase or decrease in the balance sheet so as to provide clear information in the cash flow statement in regards to non-cash transactions.
This method is preferred by companies who are using accrual accounting when bookkeeping. These companies will first identify their net profit and make adjustments until they can identify if there was an increase or decrease at the end of their cash flow statement. Companies view this method as easier; hence it is used mostly used as compared to the direct method when preparing cash flow statements.
The indirect cash flow method focuses on creating a balance between the balance sheet and the income statement. A company’s accountant will try to find the increase or decrease of the company’s assets and liability accounts so that they can add or remove it from the net income total. This way, they can identify an accurate figure for the cash inflow or cash outflow.
For example:
A good example of an indirect cash flow method is the cash flow statement provided above under the topic “Components of a Cash Flow Statement.”
The indirect cash flow method used shows how the statement starts from the net income and reconciles the cash by highlighting the operating, investing, and financing activities that the company participated in to bring about the increase or decrease in the final net income.
Reconciling the cash means adding or subtracting changes in the assets and liabilities from the net income as well as non-cash expenses like depreciation.
Here is another example of the indirect cash flow method:
Indirect Method Example
| Operating Activities | |
| Net Income | Amount |
| Depreciation | Amount |
| Increase in inventory | (Amount) |
| Decrease in accounts receivable | (Amount) |
| Net Cash from Operating Activities | Total Amount |
| Investing Activities | |
| Selling assets | (Amount) |
| Buying property | (Amount) |
| Net Cash from Investing Activities | Total Amount |
| Financing Activities | |
| Dividends payment | (Amount) |
| Payment of loans | (Amount) |
| Net Cash from Financing Activities | Total Amount |
| Beginning Cash Balance | (Amount) |
| Ending Cash Balance | (Amount) |
The indirect method starts from the net income and also includes non-cash transactions like depreciation. Depreciation (reduction in an asset’s value after a period of time) is usually added back since it only reduces the company’s profits but does not affect the cash flow.
Other Important Terms
Other important terms that a company should know when preparing a cash flow statement include:
Interest and cash flow
When it comes to interest and cash flow, they are presented in two different ways according to IFRS. The interest received, and interest paid by the company can be presented as operating cash flows. In other cases, interest received can be considered cash flow meant for investment, and interest paid can be considered cash flow meant for financing. However, under the GAAP, the interest received and paid is considered cash flow meant for business operations.
Free cash flow
Free cash flow is usually calculated in different methods and meant for different purposes.
For example:
Investors and finance professionals use it as a measurement for DCF valuation.
Accounts receivable and cash flow
Accounts receivable involves any increase or decrease in the net earnings between a particular accounting period to another. It is important to indicate it in the cash flow to ensure the company has proper financial records. The accounts receivable might increase or decrease depending on the cash being added to or being deducted from the company.
A decrease in accounts receivable is usually based on money flowing into the company through customers paying off their debts and credits. This increase in accounts receivable must be added to the net earnings of the company. However, any increase spotted in the accounts receivable must be subtracted from the company’s net earnings.
Note: An increase in accounts receivable is part of the company’s revenue and not its cash flow. That is why it must be deducted from the net earnings.
Inventory value and cash flow
Inventory value and cash flow involve records of money spent by the company to buy unprocessed or raw materials. An increase or decrease in the inventory helps the company identify where they spent the most money.
For example; an increase occurs when the raw materials are bought using cash, while a decrease is spotted if the raw materials are bought using credit.
Any increase in the inventory value should be subtracted from the net earnings, while a decrease in the inventory value should be added to the net earnings. The exception may arise in the case of raw materials bought on credit. However, the increase usually happens in the balance sheets and must be added to the net earnings.
Negative cash flow statement
A negative cash flow statement is a poor cash flow that happens due to a company’s wrong decision to expand their business operations without properly analyzing the cash flow from one financial period to another. Although it might not always indicate something wrong with the company’s finances, a cash flow statement can help a company have a clear breakdown of its finances, avoid chasing off investors or being bankrupt.
Free Templates
Following are some free downloadable templates for you:
Final Thoughts
A cash flow statement is crucial for any company because it highlights its financial strengths and capabilities. It can be used to predict the financial position of the company in the future. This will allow the company to select the most appropriate financial management approach. Additionally, a cash flow statement allows potential investors and creditors to understand the company’s financial status.
