The Purpose of Cash Flow Statement Explained Simply

The cash flow statement is a financial tool that helps businesses understand their inflows and outflows of cash. It's a snapshot of a company's liquidity and ability to pay its debts.

A cash flow statement is essential for making informed business decisions, such as whether to invest in new projects or expand operations.

It provides a clear picture of a company's cash position, helping to identify areas where cash is being wasted or opportunities for improvement.

This statement is typically prepared at the end of each accounting period, providing a basis for future financial planning and decision-making.

A cash flow statement is a financial statement that presents the inflows and outflows of cash and cash equivalents for a business over a specific period of time.

Cash flow is categorized into three main areas: operating, investing, and financing activities, which include cash received and spent, invested and debt repayment.

This statement is required by U.S. GAAP and provides a snapshot of a company's liquidity and financial health.

Financial management uses the cash flow statement to forecast expected cash flow and meet liquidity needs.

Cash flow is calculated by subtracting outflows from inflows, providing a clear picture of a business's cash position.

A cash flow statement is a snapshot of a company's financial health, and it's broken down into three main components: operating, investing, and financing cash flows.

Operating cash flow is where a company's core business operations come into play, and it includes cash received from customers and cash paid to suppliers and employees.

Investing cash flow is all about the company's big-ticket purchases, like property, equipment, and investments in other companies.

Financing cash flow results from changes in a company's capital structure, including borrowing and repaying bank loans or bonds, issuing and buying back shares, and paying dividends.

Operating activities are the lifeblood of any business, and understanding how they generate cash flow is crucial for making informed financial decisions.

Operating activities cash flow is net cash generated from a company's normal operating business activities, flowing to net income. This is the cash flow that comes from a company's core business operations, such as sales, purchases, and other expenses.

The statement of cash flows indirect method, which is more widely used, reconciles net income (loss) from the income statement to cash flow from operating activities. This method includes reconciling items like changes in working capital balances and adding back non-cash items like depreciation and amortization.

In business analysis, working capital is current assets less current liabilities in financial statements prepared using the accrual basis of accounting. Current assets and current liabilities are within one year (short-term) or the length of the business operating cycle.

The formula for operating cash flow (cash flow from operations) is: Operating Cash Flow = Operating Income + (non-cash) Depreciation and Amortization – Taxes + Change in Working Capital.

Companies with a high operating cash flow ratio (over 1) have financial strength to pay amounts when due. This ratio calculates the relationship between cash flow from operations and current liabilities.

The company's chief financial officer (CFO) chooses between the direct and indirect presentation of operating cash flow. The indirect presentation is more common and presents operating cash flows as a reconciliation from profit to cash flow.

The items in the operating cash flow section are not all actual cash flows but include non-cash items and other adjustments to reconcile profit with cash flow.

Financing is a crucial component of a cash flow statement, and it's often misunderstood. Financing activities cash flow is the net cash generated to finance an entire company, including equity, short-term or long-term debt, and cash dividend payments.

This section covers revenue earned or assets spent on Financing Activities. Financing cash flows include cash flows associated with borrowing and repaying bank loans or bonds and issuing and buying back shares. The payment of a dividend is also treated as a financing cash flow.

Borrowing money from a bank or issuing bonds can bring in cash, but it's essential to remember that notes payable is recorded as a liability on the balance sheet. Since we received proceeds from the loan, we record it as a cash increase.

Cash flow from financing activities results from changes in a company's capital structure. This can be a significant source of cash, but it's also essential to manage debt and equity effectively to ensure long-term financial health.

Analyzing a Cash Flow Statement is crucial to understand a company's financial health. Businesses use ratios and cash flow formulas to assess liquidity and cash flow availability.

To determine the quality of earnings, compare cash from operating activities to net income. If cash from operating activities is higher, earnings are considered high-quality.

The statement of cash flows is useful for investors as it provides an overall sense of cash inflows and outflows, giving a general understanding of the company's performance. If a company is funding losses or financing investments by raising money, it will be clear on the statement of cash flows.

Analyzing a cash flow statement can seem daunting, but it's actually quite straightforward. To start, you need to understand what each section of the statement is telling you.

Cash flow from operating activities is a crucial part of the statement, and it's where you'll find most of your cash flow. This includes the cash you earn from selling your products or services, minus the cash you spend on ingredients, labor, and other expenses.

One key thing to look out for is the difference between net income and cash flow from operating activities. If cash flow from operating activities is higher than net income, it means your earnings are of high quality. This is because net income only shows the profit you've made, but cash flow from operating activities shows the actual cash you've received.

You can compare cash from operating activities to net income to determine the quality of earnings.

Here are some key items to look for in the cash flow from operating activities section:

By understanding these key items, you can get a clear picture of your business's cash flow and make informed decisions about your finances.

Profit is the amount shown on an income statement after revenue and cost of goods sold are recorded to compute gross profit, operating expenses are deducted, and non-cash expenses are recorded.

Profit before tax and profit after income tax (net income) are displayed on financial statements.

Accounting for profit generally uses accrual accounting rather than cash-basis accounting.

Profit is a key metric for businesses, but it's not the only important one - cash flow is equally crucial for maintaining operational efficiency.

The Debt Service Coverage Ratio (DSCR) is a crucial metric in analyzing a company's cash flow statement. It measures a company's ability to pay its debt obligations.

Debt service is calculated by adding principal and interest payments, as well as recurring contributions to a sinking fund to repay debt. This calculation is typically done for the same time period as the company's net operating income or EBITDA.

A higher DSCR indicates a company has more than enough cash to cover its debt obligations, while a lower ratio suggests the company may struggle to meet its debt payments.

The indirect method of presenting cash flows is the most commonly used approach. Most companies report using this method, although some may use the direct method.

The indirect method begins with a measure of profit, such as net income, operating profit, or earnings before tax. Some companies may have discretion in choosing which profit metric to use.

To reconcile the profit to operating cash flow, you'll need to make adjustments for items like depreciation, amortization, impairment expense, and changes in working capital. These adjustments will help you get down to an operating cash flow number.

Here's a breakdown of the key components involved in the indirect method:

The exact adjustments made will depend on the starting point profit and the specific transactions recorded on the income statement.

Creating a cash flow statement is a straightforward process that starts with your income statement and balance sheet. You simply add back non-cash items and remove changes in assets and liabilities that didn't involve actual cash.

To create a cash flow statement, you'll need to follow the four rules for converting information from an income statement to a cash flow statement. This involves adding back depreciation and accounts payable, and removing accounts receivable.

Here are the main components of a cash flow statement:

A well-crafted cash flow statement can help you predict future cash flows and make informed business decisions. By using a cash flow statement, you can ensure you have enough liquidity to meet your financial obligations and make the most of your business opportunities.

As a helpful AI assistant, I can assist you in creating and using a cash flow statement. A cash flow statement is a powerful financial report that shows your liquidity, changes in assets, liabilities, and equity, and helps you predict future cash flows.

The four rules for converting information from an income statement to a cash flow statement are: net income stays the same, depreciation and accounts payable are added back to cash, and accounts receivable are subtracted from cash.

To create a cash flow statement, you need to start with your income statement and balance sheet. For example, let's say you have a net income of $3,500, and your accounts payable increased by $5,500. You would add these back to cash, but subtract accounts receivable of $4,000.

Here's a breakdown of the three main sections of a cash flow statement:

A cash flow statement required by U.S. generally accepted accounting principles (GAAP) includes beginning cash and cash equivalents, three main sections of operating activities, investing activities, and financing activities, ending cash and cash equivalents balance, and non-cash investing & financing disclosure items.

Investing is a crucial aspect of a company's cash flow statement, and it's essential to understand what it entails. Investing activities cash flow includes cash inflows from the sale of equity and debt investments, as well as the collection of principal on loans issued to borrowers.

Cash inflows from the sale of equity and debt investments can be a significant source of cash for a company. This can include the sale of fixed assets, insurance proceeds for fixed assets, and the sale of other companies through mergers and acquisitions.

Investing cash flow also includes the acquisition and disposal of non-current assets and other investments not included in cash equivalents. This can include the purchase or sale of property, plant, and equipment (PP&E), as well as other non-current assets and financial assets.

Cash spent on purchasing PP&E is called capital expenditures (CapEx), which can be a significant cash outflow for a company. This can include purchases of new office equipment, land, and buildings to support business operations.

As a business owner, it's essential to understand how investing activities affect your company's cash flow. The cash flow from investing activities section of your statement will show the impact of these transactions on your cash position.

Creating a budget is essential to managing your business's cash flow. It helps you project sources and applications of funds for upcoming time periods.

A cash flow budget is like a recipe for your business, and cash is the main ingredient that makes it operate smoothly. Without adequate cash, your business can't function, as many transactions require cash to complete.

By creating a cash flow budget, you can identify cash deficit periods in advance and take corrective actions to alleviate them. This may involve shifting the timing of certain transactions or determining when money will be borrowed.

You can also use a cash flow budget to identify periods of excess cash and direct that cash into interest-bearing assets where additional revenue can be generated.

Creating a cash flow budget is crucial for any business, as it helps project sources and applications of funds for upcoming time periods. This allows you to identify cash deficit periods in advance, giving you time to take corrective actions.

By creating a cash flow budget, you can also identify periods of excess cash, which can be directed into interest-bearing assets to generate additional revenue.

To create an effective cash flow budget, consider the following:

Cash flow forecasting is another essential tool for managing your business's finances. It projects cash needs and cash balances by time period and includes cash inflow and cash outflow by category.

The cash flow statement provides cash receipt and cash payment information and reconciles the change in cash for a period of time. This statement shows what caused the change in cash from the beginning of the period to the end of the period.

Net cash flow is a key metric to understand, as it represents cash inflows less cash outflows. This is a simple yet crucial concept to grasp when analyzing a company's cash flow.

Cash equivalents, such as short-term investments, can be readily converted to cash and have an original maturity date of three months or less. This is important to consider when evaluating a company's liquidity.

Free cash flow is operating cash flow minus capital expenditures, which gives us a sense of a company's ability to generate cash after investing in its operations. This is a vital metric for investors and analysts to understand.

Discounted cash flow, on the other hand, is the present value of estimated future cash flows related to a potential project. This is often used to evaluate and compare potential business investments.

Here are some key cash flow statement metrics to keep in mind:

The cash flow statement is a crucial tool for businesses to understand their financial health, and it's presented in two main methods: the direct and indirect methods.

The indirect method is the most commonly used method, and it starts with a measure of profit, such as net income, operating profit/EBIT, or earnings before tax.

Many companies use net income as the starting point, but others may use operating profit/EBIT or earnings before tax.

The indirect method requires adjustments to be made to get to the operating cash flow number, which can be affected by the exact starting point for the reconciliation.

Here's a breakdown of the key components involved in the indirect method:

The direct method, on the other hand, shows the major classes of gross cash receipts and gross cash payments, but it's less commonly used due to the additional legwork and organization required.

Smaller businesses typically prefer the indirect method, but even if a business uses the direct method, they'll still need to use the indirect method to reconcile their statement of cash flows with their income statement.

The choice of method ultimately depends on the company's preference, and there's no one-size-fits-all approach.

To get started with creating a cash flow statement, you can download CFI's free template and start practicing today. This will help you understand the different components and how to organize your financial data.

CFI's free Excel template is available for download, making it easy to start creating your own cash flow statement.

If you're new to creating cash flow statements, it's great to have a template to guide you. Download CFI's Free Statement of Cash Flows Template to get started.

CFI's free template is available for download and can be used to practice creating cash flow statements. This template is a great resource for those who want to learn how to create a cash flow statement from scratch.

Having a template can save you time and help you stay organized as you work on your cash flow statement.

A cash flow statement is a powerful tool for understanding how a company's cash is being used. It's usually broken down into three sections: Cash Flow from Operating Activities, Cash Flow from Investing Activities, and Cash Flow from Financing Activities.

In the example provided, we see that the statement of cash flows is filled with dollar amounts in black and red. Black dollar amounts increase cash, while red dollar amounts decrease it. For instance, a $30,000 increase in inventory means we bought $30,000 worth of inventory, decreasing our cash balance by that amount.

You'll notice that some expenses are recorded as red dollar amounts, but then added back to net income. This is because expenses like depreciation don't actually decrease cash. In the example, depreciation is recorded as a $20,000 expense on the income statement, but it's added back to net income because it doesn't affect our cash on hand.

The statement also shows how accounts payable is recorded as an expense on the income statement, but then added back to cash because we owe the money, not because we've paid it. In this case, let's say it's paying contractors to build a new goat pen. We owe $10,000, but we haven't paid it yet, so we add that amount back to our cash on hand.

Here's a quick rundown of how to read the cash flow statement: