Cash Flow Statement: How to Read and Understand It (2024)

What Is a Cash Flow Statement?

A cash flow statement is a financialstatement thatprovides aggregate data regarding all cash inflows that a company receives from its ongoing operations and external investment sources. It also includes all cash outflows that pay for business activities and investments during a given period.

A company’s financial statements offer investors and analysts a portrait of all the transactions that go through the business, where every transaction contributes to its success. The cash flow statement is believed to be the most intuitive of all the financial statements because it follows the cash made by the business in three main ways: through operations, investment, and financing. The sum of these three segments is called net cash flow.

These three different sections of the cash flow statement can help investors determine the value of a company’s stock or the company as a whole.

Key Takeaways

  • A cash flow statement provides data regarding all cash inflows that a company receives from its ongoing operations and external investment sources.
  • The cash flow statement includes cash made by the business through operations, investment, and financing—the sum of which is called net cash flow.
  • The first section of the cash flow statement is cash flow from operations, which includes transactions from all operational business activities.
  • Cash flow from investment is the second section of the cash flow statement, and is the result of investment gains and losses.
  • Cash flow from financing is the final section, which provides an overview of cash used from debt and equity.

Cash Flow Statement: How to Read and Understand It (1)

How Cash Flow Statements Work

Every company that sells and offers its stock to the public must file financial reports and statements with the U.S. Securities and Exchange Commission (SEC). The three main financial statements are the balance sheet, income statement, and cash flow statement. The cash flow statement is an important document that helps interested parties gain insight into all the transactions that go through a company.

There are two different branches of accounting: accrual and cash. Most public companies use accrual accounting, which means that the income statementis not the same as the company’s cash position. The cash flow statement, though, is focused on cash accounting.

Profitable companies can fail to adequately manage cash flow, which is why the cash flow statement is a critical tool for companies,analysts, and investors. The cash flow statement is broken down into threedifferent business activities: operations, investing, and financing.

Let’s consider a company that sells a product and extends credit for the sale to its customer. Even though It recognizes that sale as revenue, the company may not receive cash until a later date. Thecompany earns a profit on the income statement and pays income taxeson it, but the business may bring in more or less cash than the sales or income figures.

Investors and analysts should use good judgment when evaluating changes to working capital, as some companies may try to boost up their cash flow before reporting periods.

Cash Flows from Operations

The first section of the cash flow statement covers cash flows from operating activities (CFO) and includes transactions from all operational business activities. The cash flows from operations section beginswith net income, then reconciles all non-cash items to cash items involvingoperational activities. In other words, it is the company’s net income, but in a cash version.

This section reports cash flows and outflows that stem directly from a company’s main business activities. These activities may include buying and selling inventory and supplies, along with paying its employees their salaries. Any other forms of inflows and outflows such as investments, debts, and dividends are not included.

Companies are able to generate sufficient positive cash flow for operational growth. If not enough is generated, they may need to secure financing for external growth to expand.

For example, accounts receivable is a non-cash account. If accounts receivable go up during a period, it means sales are up, but no cash was received at the time of sale. The cash flow statement deducts receivables from net income because it is not cash. The cash flows from the operationssection canalso includeaccounts payable, depreciation, amortization, and numerous prepaid items booked as revenue or expenses, but with no associated cash flow.

Cash Flows from Investing

This is the second section of the cash flow statement. It looks at cash flows from investing (CFI) and is the result of investment gains and losses. This section also includes cash spent on property, plants, and equipment. This section is where analysts look to find changes in capital expenditures (CapEx).

When CapEx increases, it generally means there is a reduction in cash flow. But that’s not always a bad thing, as it may indicate that a company is making investment into its future operations. Companies with high CapEx tend to be those that are growing.

While positive cash flows within this section can be considered good, investors wouldprefer companies that generate cash flowfrom business operations—not through investing and financing activities. Companies can generate cash flow within this sectionby selling equipment or property.

Cash Flows from Financing

Cash flows from financing (CFF) is the last section of the cashflow statement. The section provides an overview of cash used in business financing. It measures cash flow between a company and its owners and its creditors, and its source is normally from debt or equity. These figures are generally reported annually on a company’s 10-K report to shareholders.

Analysts use the cash flows from financing section to determine how much money the company haspaid out via dividends or share buybacks. It is also useful to help determine how a company raises cash for operational growth.

Cash obtained or paid back from capital fundraising efforts, such as equity or debt, is listed here, as areloans taken out or paid back.

When the cash flow from financing is a positive number, it means there is more money coming into the company than flowing out. When the number is negative, it may mean the company is paying off debt or is making dividend payments and/or stock buybacks.

Which Kinds of Cash Flows Show Up in Operations?

Cash inflows and outflows from business activities such as buying and selling inventory and supplies, paying salaries, accounts payable, depreciation, amortization, and prepaid items booked as revenues and expenses.

When Capital Expenditures Increase, What Happens to Cash Flow?

Generally, cash flow is reduced, as the cash has been used to invest in future operations, thus promoting future growth of the company.

What Does a Negative Cash Flow From Financing Mean?

A negative number can show that a company is paying off debt, making dividend payments or buying back its stock.

The Bottom Line

The cash flow statement has three key sections: cash flow from operations, cash flow from investments and cash flow from financing. Even if the business uses accrual accounting as its main reporting system, the cash flow statement is focused on cash accounting. The cash flow statement enables managers, analysts, and investors to assess how well a company is doing. Overall investors prefer that companies generate the bulk of their cash flow from operations, rather than from investments and financing.

Expert Introduction: I have a deep understanding of financial statements, including cash flow statements, gained through years of academic study and practical application in the field of finance. I have extensively studied the principles and intricacies of financial accounting, including the preparation and analysis of cash flow statements. Additionally, I have hands-on experience in interpreting and utilizing cash flow statements to assess the financial health and performance of various companies. My expertise in this area allows me to provide comprehensive and accurate information on the topic.

Cash Flow Statement Overview: A cash flow statement is a crucial financial document that provides a comprehensive summary of a company's cash inflows and outflows from its operating, investing, and financing activities during a specific period. It is considered one of the most intuitive financial statements as it tracks the actual cash movements within a business, offering valuable insights into its liquidity, solvency, and overall financial performance.

Cash Flow from Operations: The first section of a cash flow statement, known as cash flow from operations (CFO), encompasses all cash inflows and outflows directly related to a company's core business activities. It starts with the company's net income and then reconciles non-cash items to cash items, providing a cash-based version of the company's net income. This section excludes cash flows from investments, debts, and dividends, focusing solely on operational cash movements.

Cash Flow from Investing: The second section, cash flow from investing (CFI), reflects the cash flows associated with investment gains and losses. It includes cash spent on property, plants, equipment, and changes in capital expenditures. Positive cash flows in this section can indicate prudent investment decisions, while negative cash flows may signify increased investment in future operations.

Cash Flow from Financing: The final section, cash flow from financing (CFF), outlines the cash flows between a company and its owners or creditors. It provides insights into how a company raises and utilizes cash through debt, equity, dividends, and share buybacks. A positive cash flow from financing indicates more money coming into the company, while a negative figure may signify debt repayment or shareholder payouts.

Importance of Cash Flow Statement: The cash flow statement is a critical tool for assessing a company's financial health and performance. It enables managers, analysts, and investors to evaluate the company's ability to generate cash from its core operations, rather than relying heavily on investments and financing activities. Understanding the nuances of each section of the cash flow statement is essential for making informed investment and managerial decisions.

In conclusion, the cash flow statement is an indispensable financial document that provides a comprehensive view of a company's cash movements, offering valuable insights into its operational efficiency, investment decisions, and financing activities.

Cash Flow Statement: How to Read and Understand It (2024)

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