Cash Flow Statement

Definition:
The cash flow is the revenue or expense stream that changes a cash account over a given period. Cash inflows usually arise from one of three activities – financing, operations or investing – although this also occurs as a result of donations or gifts in the case of personal finance. Cash outflows result from expenses or investments. This holds true for both business and personal finance.

The Cash Flow Statement is a mandatory part of a company’s financial reports since 1987, records the amounts of cash and cash equivalents entering and leaving a company. The Cash Flow Statement (CFS) allows investors to understand how a company’s operations are running, where its money is coming from, and how it is being spent.

Here you will learn how the CFS is structured and how to use it as part of your analysis of a company.

The cash flow statement is distinct from the income statement and balance sheet because it does not include the amount of future incoming and outgoing cash that has been recorded on credit. Therefore, cash is not the same as net income, which, on the income statement and balance sheet, includes cash sales and sales made on credit. Cash flow is determined by looking at three components by which cash enters and leaves a company: core operations, investing and financing.

Operations

Measuring the cash inflows and outflows caused by core business operations, the operations component of cash flow reflects how much cash is generated from a company’s products or services. Generally, changes made in cash, accounts receivable, depreciation, inventory and accounts payable are reflected in cash from operations.
Cash flow is calculated by making certain adjustments to net income by adding or subtracting differences in revenue, expenses and credit transactions (appearing on the balance sheet and income statement) resulting from transactions that occur from one period to the next. These adjustments are made because non-cash items are calculated into net income (income statement) and total assets and liabilities (balance sheet). So, because not all transactions involve actual cash items, many items have to be re-evaluated when calculating cash flow from operations.
For example, depreciation is not really a cash expense; it is an amount that is deducted from the total value of an asset that has previously been accounted for. That is why it is added back into net sales for calculating cash flow. The only time income from an asset is accounted for in CFS calculations is when the asset is sold.
Changes in accounts receivable on the balance sheet from one accounting period to the next must also be reflected in cash flow. If accounts receivable decreases, this implies that more cash has entered the company from customers paying off their credit accounts – the amount by which AR has decreased is then added to net sales. If accounts receivable increase from one accounting period to the next, the amount of the increase must be deducted from net sales because, although the amounts represented in AR are revenue, they are not cash.
An increase in inventory, on the other hand, signals that a company has spent more money to purchase more raw materials. If the inventory was paid with cash, the increase in the value of inventory is deducted from net sales. A decrease in inventory would be added to net sales. If inventory was purchased on credit, an increase in accounts payable would occur on the balance sheet, and the amount of the increase from one year to the other would be added to net sales.
The same logic holds true for taxes payable, salaries payable and prepaid insurance. If something has been paid off, then the difference in the value owed from one year to the next has to be subtracted from net income. If there is an amount that is still owed, then any differences will have to be added to net earnings.

What are the components of a cash flow statement?

Cash flow statements are divided into three main parts. Each part reviews the cash flow from one of three types of activities: (1) operating activities; (2) investing activities; and (3) financing activities.

1. Cash flow from operating activities: represents the amount of money a company brought in from its regular business activities. This includes cash generated through manufacturing and selling goods or providing services to customers. It also includes cash paid to suppliers and taxes paid.
2. Cash flow from investing activities: reflects transactions that a company makes to invest in resources for growth and production that involve long-term uses of cash. This includes cash paid for the purchase of fixed assets like property, a factory, or equipment. On the other hand, it also includes cash received from selling property or equipment, or as a result of a merger.
3. Cash flow from financing activities: focuses on how a company raises capital and how it pays it back to investors and creditors. This includes paying cash dividends, issuing or buying back more stock, and adding or changing loans. 

Who is interested in a cash flow statement?

There are three main groups who are interested in a company’s cash flow statement:

• Investors: will review the cash flow statement to understand how well a company’s operations are running and to view their ability to generate cash and meet their obligations.
• Lenders/Creditors: will review the cash flow statement to determine how much cash is available for the company to fund its operation and pay its debts.
• Management: the accountants, the Chief Financial Officer (CFO), the Chief Executive Officer (CEO) are some of the management team who will review the numbers of the cash flow statement to know whether the company is prepared to cover their payroll and other expenses.