What is Cash Flow Statement: Meaning, Advantages, Format, Importance, Structure and Examples

Cash flow, the lifeblood of any business, embodies the ebb and flow of monetary resources, influencing a company's financial health and operational capabilities. Mastering its intricacies through the cash flow statement is essential for informed decision-making and sustainable business growth. Understanding the business environment in which a company operates can play a significant role in managing cash flow effectively.

What is a cash flow statement?

A cash flow statement is one of the primary financial statements that businesses and investors use to gauge a company's financial performance and health. It provides detailed insight into how a company receives and uses cash in a specific time period. The statement encompasses cash activities across three categories: operating, investing, and financing.

By analysing a cash flow statement, stakeholders can gauge a company's liquidity, its ability to cover expenses, pay dividends, and reinvest into business growth. Furthermore, understanding the cash flow statement can also shed light on how effective the company is at utilising its cash resources.

How cash flow statements work?

A cash flow statement is a financial document that provides a detailed summary of a company’s cash inflows and outflows over a specific period. It is divided into three main sections: operating activities, investing activities, and financing activities.

1. Operating activities: Includes cash generated from core business operations, such as sales and payments to suppliers.
2. Investing activities: Reflects cash spent on or received from the purchase and sale of assets, like equipment or investments.
3. Financing activities: Encompasses cash flows from transactions with the company’s investors, such as issuing shares or paying dividends.

By analysing these sections, stakeholders can assess the company's liquidity, financial health, and long-term viability.

Structure of the cash flow statement

A cash flow statement provides insights into the inflow and outflow of cash within an organisation over a specific period. Here is a detailed look at the details present in a cash flow statement:

1. Operating activities: Records cash generated from primary business operations, such as sales revenue, payments to suppliers, and salaries to employees.
2. Investing activities: Highlights cash flows related to investments in assets, like property, equipment, or securities, as well as proceeds from asset sales.
3. Financing activities: Tracks cash flows from sources like loans, equity issuance, or dividends paid to shareholders, reflecting how the company funds its operations and expansion.
4. Net cash flow: Summarises the overall cash position by combining cash flows from operating, investing, and financing activities, indicating whether there was a net increase or decrease in cash during the period.
5. Supplementary information: Includes additional details to enhance understanding, such as non-cash transactions, exchange rate effects, and significant investing or financing events.

Objectives of cash flow statement

The cash flow statement plays a key role in assessing financial health and cash management. Its main purposes include:

• Measuring cash generation: Analyzing how much cash is produced from daily operations to ensure there is enough to cover expenses and financial commitments.
• Monitoring cash usage: Tracking how cash is allocated for investments and financing activities, such as acquiring assets or repaying loans, to determine the effectiveness of financial decisions.
• Assessing liquidity and solvency: Ensuring there is sufficient cash available to meet short-term payment obligations and financial responsibilities.
• Identifying cash flow patterns: Recognizing trends and fluctuations in cash flow over time to support better financial planning and decision-making.
• Reviewing cash management strategies: Evaluating how efficiently cash is handled, including inflows and outflows, to enhance financial operations.
• Supporting financial analysis: Offering a clear picture of cash sources and utilization, helping investors, lenders, and stakeholders assess financial stability and performance.

By fulfilling these objectives, the cash flow statement provides insights into cash availability, helps evaluate the ability to generate funds, and aids in making well-informed financial decisions.

Format of a cash flow statement

A cash flow statement is organized into three main sections, each detailing different aspects of cash movement. The operating activities section captures cash flows related to the company’s core business operations, including receipts from sales of goods and services and payments to suppliers and employees, highlighting the company’s ability to generate cash from its primary activities. The investing activities section reflects cash used in or generated from investments in long-term assets, such as the purchase or sale of property, equipment, or securities. Lastly, the financing activities section includes cash flows from transactions with investors and creditors, such as issuing shares, borrowing, repaying debt, and paying dividends.

How is a cash flow statement organized?

As mentioned above, a cash flow statement is divided into three main sections: operations, investing, and financing. These are outlined as follows:

Cash flows from operations (CFO)

The first section covers cash flows from operating activities (CFO) and includes transactions from the company’s core business operations. This section starts with net income and adjusts all non-cash items to reflect cash-based operational activities. In simple terms, it is the cash version of a company’s net income.

This section reports the cash inflows and outflows related to the company’s primary business activities, such as purchasing and selling inventory, paying employee salaries, and other operational expenses. Transactions like investments, debts, and dividends are excluded from this section.

Companies need to generate enough positive cash flow from operations to fund growth. If they cannot generate sufficient cash, they may need external financing for expansion. Having a firm grasp on the working capital cycle can help businesses manage cash flow more efficiently.

For example, accounts receivable is a non-cash account. If accounts receivable increase during a period, it indicates higher sales, but no cash was received at the time of the sale. The cash flow statement deducts these receivables from net income because they do not represent cash. This section may also include accounts payable (debts yet to be paid), depreciation, amortisation, and prepaid items recorded as revenue or expenses without corresponding cash flow.

Cash flows from investing (CFI)

The second section of the cash flow statement covers cash flows from investing activities (CFI). This includes investment gains and losses, as well as cash spent on property, plant, and equipment. Analysts often review this section to track changes in capital expenditures.

An increase in capital expenditures usually reduces cash flow. However, this may not always be negative, as it can signal that the company is investing in its future operations. Companies with high capital expenditures are often those experiencing growth.

Positive cash flows in this section, such as from the sale of equipment or property, are generally considered favourable. However, investors typically prefer companies to generate cash flow primarily from operations rather than selling assets.

Cash flows from financing (CFF)

The third section of the cash flow statement focuses on cash flows from financing activities (CFF). This section outlines how much cash is used or generated through business financing and tracks the financial interactions between a company and its owners or creditors. Cash flow here typically arises from debt or equity, such as the sale of stocks and bonds or bank loans. These figures are usually reported annually in the company’s 10-K report.

Analysts use the CFF section to see how much cash a company has distributed via dividends or share buybacks. This section is also helpful in understanding how a company raises capital for its operational growth. Cash obtained or repaid through capital-raising efforts and loans is recorded here.

A positive cash flow from financing indicates more cash is coming into the company than going out. Conversely, a negative number suggests the company is repaying debt, making dividend payments, or buying back shares.

How cash flow is calculated

Cash flow is calculated by adjusting net income for non-cash items and changes in working capital. This involves reconciling net income with actual cash generated or used during a specific period.

What is the cash flow formula?

There are two methods for calculating cash flow: the direct method and the indirect method.

Direct cash flow method

The direct method sums up all cash payments and receipts, such as cash paid to suppliers, receipts from customers, and cash paid out for salaries. This method of preparing a cash flow statement (CFS) is simpler for very small businesses that follow the cash basis accounting method.

These figures can also be calculated by analysing the beginning and ending balances of various asset and liability accounts, determining the net decrease or increase in these accounts. It presents cash flow in a clear and straightforward way.

Indirect cash flow method

In the indirect method, cash flow is calculated by adjusting net income, adding or subtracting differences arising from non-cash transactions. Non-cash items are reflected in the changes to a company’s assets and liabilities on the balance sheet between periods. The accountant will adjust net income by accounting for any increases or decreases in asset and liability accounts to accurately reflect cash inflows and outflows.

Changes in accounts receivable (AR) on the balance sheet from one accounting period to the next are also considered in cash flow:

• If AR decreases, more cash may have been received from customers paying off their credit accounts. The decrease in AR is then added to net income.
• If AR increases, it must be deducted from net income, as the revenue represented by AR has not yet been received in cash.

Changes in inventory are similarly reflected on the CFS

• An increase in inventory indicates that the company has spent more on raw materials, meaning the increase in inventory value is deducted from net income.
• A decrease in inventory is added to net income. Credit purchases, represented by an increase in accounts payable, are added to net income based on the increase in accounts payable from one year to the next.

This logic also applies to taxes payable, salaries, and prepaid insurance. If a liability has been paid off, the difference in value owed from one year to the next is subtracted from net income. If there are still amounts owed, any differences are added to net income.

How to prepare a cash flow statement?

Here's a step-by-step guide to preparing a cash flow statement:

1. Operating activities

• Start with net income from the income statement.
• Adjust for non-cash items like depreciation and amortization.
• Account for changes in working capital such as receivables, payables, and inventory.

2. Investing activities:

• List cash flows from buying and selling long-term assets.
• Include investments in securities or loans made by the company.

3. Financing activities:

• Record cash flows from issuing or repurchasing stock.
• Include cash from borrowing or repaying loans and bonds.
• Note dividends paid to shareholders.

4. Calculate net cash flow

• Sum all cash flows from operating, investing, and financing activities.
• Determine the net increase or decrease in cash for the period.

5. Reconcile with financial statements

• Ensure the ending cash balance reconciles with the balance sheet.
• Verify that net cash flow matches the change in cash reported on the balance sheet.

6. Finalise and analyse

• Review the cash flow statement for insights into liquidity and financial health.
• Use the statement to assess the company's ability to generate cash and manage its cash resources effectively.

Understanding capital structure and cost of capital can also influence a company’s financial management and its approach to funding growth while managing risk.

How is the cash flow statement used

The cash flow statement is a pivotal financial tool used to evaluate a company's financial performance. It offers insights into the sources and uses of cash, aiding in decision-making regarding investments, financial planning, and business operations.

Example of a cash flow statement

In a cash flow statement, the operating section might show cash from sales, the investing section cash used for equipment, and the financing section cash from a loan. This breakdown aids in understanding a company's cash movements.

Cash flow statement vs. fund flow statement

Here’s a comparison showing the difference between cash flow and a fund flow statement:

Aspect	Cash Flow Statement	Fund Flow Statement
Purpose	Shows inflows and outflows of cash during a specific period.	Shows the sources and uses of funds, indicating changes in financial position.
Focus	Focuses on liquidity and cash management.	Focuses on the overall financial health and working capital of a business.
Components	Operating Activities, Investing Activities, Financing Activities.	Sources of Funds (like equity, loans), and Application of Funds (like asset purchase, debt repayment).
Time period	Typically covers a short-term period (monthly, quarterly, annually).	Usually covers a longer period (annually).
Basis	Based on actual cash inflows and outflows.	Based on changes in working capital and fund balances.
Objective	To assess the company's ability to generate and manage cash efficiently.	To analyze changes in financial structure and fund flow between two balance sheet dates.
Nature of transactions	Only cash-based transactions are considered.	Both cash and non-cash transactions affecting funds are considered.
Types of activities	Classified into Operating, Investing, and Financing Activities.	Classified into Sources and Applications of Funds.
Financial indicators	Provides insights into cash liquidity and operational cash generation.	Provides insights into the financial stability, capital structure, and fund management.
Key analysis	Cash position at the beginning and end of the period.	Working capital movement between two balance sheet dates.
Method of preparation	Prepared using direct or indirect method.	Prepared by analyzing changes in non-current assets, non-current liabilities, and working capital.
Regulation	Required by accounting standards (like IFRS and GAAP).	Not mandated by accounting standards but useful for internal management analysis.

Understanding and managing cash flow is critical for businesses. The cash flow statement provides valuable insights, helping businesses make informed decisions and maintain financial stability. Explore the business loan from Bajaj Finance for financial support in managing your business's cash flow.

Advantages of cash flow statement

Here are some of the advantages of cash flow statement:

1. Clear liquidity analysis: The cash flow statement provides a clear view of a company's cash inflows and outflows, offering insight into its liquidity position.
2. Effective cash management: It aids in managing cash by identifying periods of surplus or shortage.
3. Performance evaluation: The statement helps assess the company’s operational efficiency and ability to generate cash from core activities.
4. Investment insights: Investors use it to gauge a company’s ability to generate returns and manage debts.
5. Predictive value: It assists in forecasting future cash flows, supporting strategic financial planning.

Limitations of the cash flow statement

While the cash flow statement is essential for financial analysis, it has certain limitations that should be considered:

• Excludes non-cash items: The cash flow statement does not account for non-cash transactions such as depreciation or changes in asset values, which can limit the completeness of the financial picture.
• Based on historical data: It reflects past cash movements and may not accurately depict a company's current or future financial position due to timing differences.
• Does not include future cash flows: It focuses on past and present cash flows, ignoring projections or expected changes in cash flow.
• Limited profitability assessment: It does not directly measure net income or profitability, meaning a company can have strong cash flow but low profits, or vice versa.

Despite its utility, the cash flow statement has limitations, such as not accounting for non-cash expenses. It may not fully reflect a company's financial position, necessitating supplementary analysis for a comprehensive evaluation.