Cash flow statement

Before investing in stocks of any company you must have a clear picture of its financial position. This helps you determine if it is profitable to invest or not. Only if the company has its finances in order, it will be able to manage its operations and earn profits for you. It is critical to invest in a company that is financially healthy.

There are three important financial statements – cash flow statement, balance sheet, and income statement that help you gauge a company’s financial health. The article offers a quick overview of the cash flow statement. Read on.

What is a cash flow statement?

Cash flow statement is a financial statement that summarises the movement of cash and cash equivalents in a company. Whether cash flows in or out of the company, you can see this in a cash flow statement.

Referring to a company’s cash flow statement is very insightful. From an investor’s, point of view you get to know how the company generates cash to fund its operations, pays its debts and meets other financial obligations. It also helps the company budget and forecast future cash flows.

What is the structure of a cash flow statement?

A company’s cash flow statement is typically made of three components – cash flow from operating activities, investing activities, and financing activities. It also includes disclosures from non-cash activities, only if the financial statement is prepared under Generally Accepted Accounting Principles (GAAP). Read on to further decode the cash flow statement components:

Cash flow from operating activities

Cash flow from operating activities includes uses and sources of cash related to the company’s business activities. In simple terms, it indicates the amount of cash generated from the sale of the company’s goods and services.

Following is a mention of various business activities that may be included in the cash flow statement:

• Payments made for the procurement of raw materials 
• Wage payments and salaries of employees
• Rental
• Interest payments
• Tax payments
• Receipts from the sale of the company’s goods and services
• Any other type of operating expense

If it is an investment or trading company, the receipts from the sale of Equities, Debt instruments, and loans will be included under cash flow from operating activities.

Cash flow from investment activities

Cash flow from investment activities includes uses and sources of cash associated with the company’s investments. Changes in the company’s assets, investments, and even equipment are included here. Following is a quick overview of various investment activities:

• Purchase or sale of assets
• Loans received or offered
• Payments related to mergers and acquisition

When the company purchases equipment or an asset, it comes under ‘cash out’. If an equipment or asset is sold, is mentioned under the ‘cash in’ section of the cash flow statement.

Cash flow from financing activities

Cash flow from financing activities includes sources of cash from banks and investors. This includes loan repayments and stock repurchase payments. It also includes cash paid to shareholders in the form of dividends. To put it simply, here cash in is when the company raises capital, while cash out is when dividends are paid outs.

How is cash flow calculated?

Cash flow can be calculated in two ways – direct and indirect methods. Following is a detailed description of both methods:

Direct method

The direct method is by far the simplest and most widely used calculation method for cash flow. The method simply adds up all payments and receipts of the company. This includes payments made to procure raw materials for production, employee salaries, and cash receipts from customers.

This cash basis accounting method considers the initial and final value of assets and liabilities for calculation. It also considers the net increase and decrease in the assets or liabilities value for accurate calculation.

Indirect method

Indirect method calculates the cash flow by adjusting the net income. It adjusts the net income by adding or subtracting the difference resulting from non-cash transactions. These non-cash transactions show up as changes in assets or liabilities value on the company’s balance sheet from year to year. You must identify the increase or decrease in the value and accordingly make adjustments to obtain the accurate cash flow for the current financial year.

How does the cash flow statement accommodate changes?

Following are a few examples of how the cash flow statement accommodates changes in the company’s financials:

Accounts receivable change

• Account receivable decreases – This indicates more cash entered the company. Several customers may have cleared their credit accounts. The decreased accounts receivable should be added to the net earnings.

• Account receivable increases – This indicates more cash left the company. The increased accounts receivable should be deducted from net earnings.

Typically accounts receivable are considered as revenue and not as cash flow.

Inventory changes

• Increased inventory – This indicates the company spent more money to procure raw materials. The increased inventory amount should be deducted from net earnings.

• Decreased inventory – This indicates the company spent less money or procured raw materials on credit. In either scenario, the decreased inventory value should be added to net earnings.

You can use the same logic to adjust for changes witnessed by other assets and liabilities.

Bottom line

As the name suggests, a cash flow statement is a financial summary of all cash in-flow and out-flow of a company. Referring to a company’s cash flow statement in conjunction with other statements gives a good idea about its financial health.

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