Understanding cash flow statement (CFS) helps assess a company's liquidity and cash flow investments. It tracks cash entering and leaving the business. This insight aids strategic financial planning.
A profit and loss statement (P&L) shows revenue, costs, and expenses over a period. It highlights a company's profitability by detailing its financial performance.
Cash flow statement (CFS) and profit and loss statement (P&L) provide different perspectives on financial health. CFS focuses on liquidity, while P&L focuses on profitability.
The cash flow statement is divided into operating, investing, and financing activities, each revealing distinct aspects of cash management.
CFS shows cash generated and used in core business operations, essential for day-to-day financial decisions.
CFS highlights how a business funds its operations and growth, through loans, equity, and dividends, aiding in strategic financing decisions.
CFS helps understand cash flow investments, including asset purchases and sales, which are crucial for long-term growth planning.
Learning Materials
What Is a Cash Flow Statement (CFS)?
A Cash Flow Statement (CFS) shows cash inflows and outflows. It helps in understanding the income statement and analyzing cash transactions. The CFS complements the statement of revenue and expense. It provides insights beyond income statement analysis by focusing on actual cash movements.
Structure of the Cash Flow Statement
The cash flow statement format has three sections: Operating, Investing, and Financing activities. Operating activities include cash from daily business operations. Investing activities cover cash used for assets and investments. Financing activities show cash from loans and equity. This format helps understand a company's cash sources and uses.
Cash Flow From Operating Activities
Cash flow from operating activities reflects the cash generated or used by a company's core business operations. It includes all cash receipts and payments related to the business's primary activities.
Cash Received from Customers: The cash collected for goods sold or services provided. It is the primary source of cash inflow for most businesses.
Cash Paid to Suppliers and Employees: This covers payments made to suppliers for raw materials, inventory, and other operational expenses. It also includes wages and salaries paid to employees.
Other Operating Cash Payments and Receipts: This can include payments for utilities, rent, and other essential operating expenses. It may also cover receipts from miscellaneous operating sources, such as refunds or rebates.
Cash Flow From Investing Activities
Cash flow from investing activities focuses on cash transactions related to long-term assets and cash flow investments. It includes both the cash spent on acquiring assets and the cash received from selling them.
Purchasing Assets: This involves spending cash to buy long-term assets like equipment, property, and technology. These investments are crucial for expanding production capacity and supporting business growth.
Selling Assets: When a company sells old or unused assets, it generates cash inflow. This can include the sale of equipment, real estate, or investments in other businesses.
Investments in Securities: Companies may invest excess cash in securities like stocks or bonds. The cash spent on purchasing these investments and the cash received from selling them are part of investing activities.
Acquisitions and Mergers: Cash used for acquiring other businesses or merging with them falls under investing activities. These strategic investments can help companies expand their market presence and capabilities.
Cash Flow From Financing Activities
Cash flow from financing activities encompasses the cash transactions related to a company's financing sources. This section details how a company raises capital and repays its financial obligations.
Issuing Equity: When a company issues new shares of stock, it generates cash inflow from investors. This equity financing provides funds without increasing debt but may dilute existing shareholders' ownership.
Borrowing Funds: Companies often take out loans or issue bonds to raise cash. The proceeds from these borrowings provide immediate capital to support business operations, expansion, or debt restructuring.
Repaying Debt: Cash outflows in this category include repayments of principal on loans and bonds. Timely repayment of debt helps maintain the company's creditworthiness and financial stability.
Dividends Paid: Distributing dividends to shareholders is another significant cash outflow. While this reflects a company's profitability and commitment to returning value to investors, it reduces the cash available for other uses.
Stock Buybacks: When a company repurchases its own shares, it uses cash to reduce the number of outstanding shares. This can help increase the value of remaining shares but involves substantial cash outflows.
How To Calculate Cash Flow?
Understanding cash flow calculation is crucial for assessing a company's financial health. There are two primary methods to calculate cash flow: the direct method and the indirect method. Each method provides valuable insights into the company's cash flow, and both use the cash flow statement formula to determine the net cash flow for a specific period.
Direct method
The direct method involves calculating cash flow by directly reporting the cash transactions related to operating activities. This method provides a clear view of cash inflows and outflows from the company's core operations.
Cash Receipts from Customers: Sum all the cash received from customers during the period. This includes cash sales and collections from accounts receivable.
Cash Payments to Suppliers and Employees: Total the cash paid out to suppliers for goods and services, as well as cash paid to employees for wages and salaries.
Other Operating Cash Payments: Include all other cash payments related to operating activities, such as utilities, rent, and taxes.
Indirect method
The indirect method starts with net income from the profit and loss statement and adjusts for non-cash transactions, changes in working capital, and other items to arrive at the net cash flow from operating activities.
Start with Net Income: Begin with the net income figure from the income statement.
Adjust for Non-Cash Items: Add back non-cash expenses such as depreciation and amortization since these do not involve actual cash outflows.
Changes in Working Capital: Adjust for changes in working capital accounts like accounts receivable, accounts payable, and inventories. For example, an increase in accounts receivable would reduce cash flow, while an increase in accounts payable would increase cash flow.
Other Adjustments: Include any other adjustments necessary to reconcile net income to net cash provided by operating activities, such as gains or losses on asset sales.
Cash Flow Forecast For Startup Business
Creating a cash flow forecast helps startups plan their financial future. A simple cash flow statement shows expected cash inflows and outflows. Start with estimating sales and collections from customers. Include anticipated payments to suppliers and employees. Factor in potential investments and financing activities. Regularly update the forecast to reflect actual cash movements. This forecast helps manage cash efficiently and avoid shortages.
How To Prepare Cash Flow Statement?
To prepare a statement of cash flow, start with gathering financial data. Organize cash flows into operating, investing, and financing activities. Use the direct or indirect method to calculate cash flow. Ensure accuracy by reconciling with your bank statements. Review and update the statement regularly. This helps track liquidity and financial health effectively.
Cash Flow Statement vs. Income Statement
The cash flow statement and income statement serve different purposes in financial analysis.
Cash Flow Statement: Focuses on the cash inflows and outflows over a specific period. It shows how a company generates and uses cash through operating, investing, and financing activities. This statement is crucial for understanding the liquidity and cash management of the business.
Income Statement: Also known as the Profit and Loss Statement, it details the company’s revenues, expenses, and profits over a specific period. It highlights the business’s profitability by showing how revenue translates into net income after deducting expenses.
While the Income Statement includes non-cash items like depreciation, the Cash Flow Statement excludes them, providing a clear picture of actual cash movements. Both statements are essential, offering complementary insights into a company's financial performance and health.
Cash Flow Statement Example
Cash flow statement analysis helps assess a company's financial health and liquidity. Let's look at a hypothetical company, AquaPure, which manufactures and sells water filtration systems.
Operating Activities
Cash Received from Customers: $200,000
Cash Paid to Suppliers and Employees: $170,000
Net Cash from Operating Activities: $30,000
Investing Activities
Cash Used for Purchasing Assets: $40,000
Proceeds from Selling Assets: $5,000
Net Cash Used in Investing Activities: -$35,000
Financing Activities
Cash from Loans: $50,000
Dividends Paid: $10,000
Net Cash from Financing Activities: $40,000
Net Increase in Cash
Total Net Cash Increase: $35,000
This example shows that AquaPure generated cash from operations, invested in new equipment, and raised funds through loans while paying dividends. Analyzing this statement helps stakeholders understand the company's cash management and financial strategy.