Your Money Revealed: Cash Flow Statements (2024)

One question is fundamental to any business: How much money is coming in versus how much isgoing out? A cashflow statement answers that and provides a clear picture of whether a company has the cash*t needs to payits debts and fund operating expenses over a set timeframe. It’s one of the mostimportantsources ofinsight into a company’s financial health.

What Is a Cash Flow Statement (CFS)?

A cash flow statement, also known as a statement of cash flows, is a financialstatement that documents thecash and cash equivalents a company generates and spends over a specific period. Cash flowstatements reveala business’s liquidity, help evaluate changes in assets, liabilities and equity, andmake iteasierwhen analyzing operating performance.

Key takeaways

• Cash flow statements show the cash impact of the decisions a company makes on operating,investing andfinancing activities.
• A cash flow statement consists of three sections: cash from operating activities, cashfrom investingactivities and cash from financing activities.
• There are two methods for cash flow statement preparation: direct and indirect.
• The direct method determines changes in cash receipts and payments. The indirect methodtakes the netincome generated in a period and adds or subtracts changes in the asset and liabilityaccounts todetermine the implied cash flow.
• A key component for any company are the changes in accounts receivable.
• Investing activities should include asset purchases and sales, interest paid on loans,and paymentsrelated to mergers and acquisitions.
• Negative cash flow is not always a cause for alarm; some businesses choose to spend moreto meetbusiness goals and may rely on financing to get them to positive cash flow generation.

Why Do Businesses Need Cash Flow Statements?

The cash flow statement serves as a bridge between the income statement and the balancesheet. There are fourkey reasons why a cash flow statement is important:

1. It reveals a business’ liquidity so that companies know just how much cash is onhand,and thus their projectedrunway to whencash is projected to run out.
2. It details the specific changes in assets, liabilities and equity.
3. It eliminates the effects of different bookkeeping techniques (for example cash basisversus accrualbasis accounting), making it easier for investors to compare multiple firms’financialperformance.
4. It helps analyze and forecast the amount, timing and probability of future cash needs.

How Cash Flow Statements Work

All publicly traded companies must file financial reports and statements with the Securitiesand ExchangeCommission (SEC). The cash flow statement is one of three critical documents, along with thebalance sheetand income statement, included in SEC filings. It provides information about cash receipts,cash paymentsand the net change in cash resulting from a company’s operating, investing andfinancingactivities.

Investors look to the cash flow statement for insights into a company’s financialfooting.Meanwhile,creditors can use the cash flow statement to gauge liquidity and determine whether a companycan fund itsoperating expenses and pay off its debts.

What Is Included in a Cash Flow Statement?

A cash flow statement consists of three key components:

• Cash flow from operating activities involves any cash flows fromcurrent assets andcurrent liabilities. This section includes transactions from all operational businessactivities,including buying and selling inventory and supplies as well as paying employee salaries.
• Cash flow from investing activities reflects results from investmentgains and losses.This section includes transactions such as equipment purchases, loans made to suppliersor mergers andacquisitions. Analysts can rely on this section to find changes in capital expenditures(CapEx).
• Cash flow from financing activities measures cash flow between acompany and its ownersand creditors. This section involves cash transactions related to raising money fromstock or debt orrepaying that debt. When cash flow from financing activities contains a positive number,it’s asign that there is more cash inflow than outflow. When the number is negative, it mayindicate that acompany is paying off debt, making dividend payments or buying back stock.

Additionally, the cash flow statement may include disclosure of non-cash activities whenprepared undergenerally accepted accounting principles (GAAP)—items like fixed asset depreciation,goodwillamortization and the like.

How is a Cash Flow Statement Produced?

There are two methods of cash flow statement preparation: direct and indirect. The bestchoice for yourbusiness depends on how much detail you need to include in your statement, as well as howmuch time you arewilling to dedicate. While both methods are GAAP-approved, the International AccountingStandards Board(IASB) prefers the direct reporting method. However, most small businesses use the indirectmethod.

Direct vs. Indirect Methods of Producing a Cash Flow Statement

The main difference between the direct method and the indirect method of presenting thestatement of cashflows (SCF) involves the cash flows from operating activities. There are no differences inthe cash flowsfrom investing activities and the cash flows from financing activities under eithermethod—the realdifference lies in the operating activities.

• Direct cash flow method: This method relies on cash-basis accounting.Finance recordsrevenues and expenses as cash is received or disbursed by the business. The directmethod requires moreorganization and legwork, since you subtract actual cash flows from inflows. Common lineitems usingthis method include customer receipts, payments to suppliers and employees, interest anddividendsreceived and income tax payments.
• Indirect cash flow method: This method is based on accrual-basisaccounting, meaningrevenue and expenses are counted when they are incurred rather than when money actuallychanges hands.Finance looks at the transactions recorded on the income statement and selectivelyreverses some of themto eliminate transactions that don’t show the movement of cash. This method alsorequiresadjustments to add back any non-operating activities, such as depreciation, thatdon’timpactoperating cash flow.

Accounts Receivable and Cash Flow

When it comes to the balance sheet, any changes in accounts receivable must be reflected incash flow. Adecrease in accounts receivable implies that more cash has entered the company fromcustomers paying offcredit accounts. The amount accounts receivable decreased is added to the company’snetsales.However, if accounts receivable increases, the amount of the increase must be deducted fromnet sales.That’s because, while accounts receivable amounts count as revenue, they are not cash.

Inventory Value and Cash Flow

When inventory increases, it indicates that a company has spent money on raw materials. Ifcash were used inthe purchase of that inventory, the increase would be deducted from net sales. On the flipside, if therewere a decrease in inventory, that would be added to net sales. If the inventory waspurchased on creditinstead of cash, the balance sheet would reflect an increase in accounts payable, and thatyear-over-yearincrease would be added to net sales.

Investing Activities and Cash Flow

Cash From Financing Activities

Financing activities involve both cash inflows and outflows from creditors. This categorycomprises the moneythat comes from investors or banks, dividend payments, and goes out for stock repurchasesand the repaymentof loans.

Not all financing activities involve the use of cash, and only activities that impact cashare reported inthe cash flow statement. Non-cash financing activities include the conversion of debt tocommon stock orissuing a bond payable to discharge the liability.

A business’ financing activities shed light on its overall financial health and goals.Forexample,positive cash flow from financing activities is indicative of growth and expansion. Moremoney flowing intoa business signifies an increase in business assets. Meanwhile, cash outflows from financingactivities cansignify improved liquidity. It may mean that a company has paid off long-term debt or made adividendpayment to shareholders.

Negative Cash Flow Statements

In general, a positive cash flow statement is a sign of a healthy company. And yet a negativecash flowstatement is not in itself cause for alarm. It may mean a business is new and has spent alot of money onproperty or equipment. Or, it could mean the business is in growth mode.

For example, Netflix had a negative cashflow(opens in new tab) for years while thecompanyincreased spending on original content. It was a gamble, but some investors saw the strategyas a positive.More original content meant the business would be better equipped to compete with otherstreaming servicesand TV networks.

Balance Sheet and Income Statement

The cash flow statement serves as a bridge between the income statement and the balance sheetby showing howcash moves in and out of a business during a specific period. The balance sheet involves acompany’sassets and liabilities from one period to the next while the income statement coversexpenses and incomeover time.

Finance can reference both the balance sheet and the income statement while preparing a cashflow statement.The net cash flow in the cash flow statement between periods should equal the change in cashbetweenconsecutive balance sheets of the period that the cash flow statement covers. The cash flowstatement isformulated by subtracting non-cash items from the income statement.

Cash Flow Statement Example

Below is an example of a cash flow statement for Macy’s department stores.