The cash flow statement may not be as popular as its other two counterparts – income statement and balance sheet. Yet, this single instrument can give a peek into one of a business’ most important aspects – whether it has money to pay its expenses and run the business.
So, we’d like to take you through some of the key facts of a cash flow statement.
1. Cash flow statement records the movement of cash in a business:
This statement is created to track how cash and cash equivalents (highly liquid investments with maturity of 90 days or less) move or flow in and out of a company. The result of this movement helps decipher how well can the business pay its debts and expenses.
2. Cash flow statement contains 3 key parts:
This statement is divided into 3 key segments:
Cash from Operating Activities: cash inflows and outflows related directly to a business’ primary operations i.e.selling a good or service such as customer receipts, salaries, interest payments, income tax payments etc.
Cash from Investing Activities: incoming or outgoing cash from a company’s investments such as assets (property, equipment, etc.)
Cash from Financing Activities: inflow and outflow of cash from capital used to finance a company’s operations such as payment of bank loan, dividends, etc.
3. Cash flow statement is prepared for a specific period of time:
Similar to the income statement, the cash flow statement is also created for a particular period such as a month, quarter or year. This is known as the accounting period. Of the three financial statements, only the balance sheet is prepared for a single point in time.
4. Cash flow statement can be constructed in two ways:
This is a straightforward method that simply adds all cash inflows from operations such as cash receipts from customers and subtracts all outflows such as cash paid to suppliers, salaries etc. Smaller businesses commonly use this method to calculate their cash flow.
This method starts off with the net income or loss, which is extracted from the income statement and adds to or subtracts from that the implicit cash flows from the balance sheet – which have not yet necessarily been paid or received in cash. Hence, this method is based on the accrual accounting system.
5. The bottom line shows the change in cash balance:
After a cash flow statement has been prepared, the last line shows the cash balance – the surplus cash left with the company or the negative cash balance (outflow more than inflow).
6. Positive cash flow doesn’t always equate to profit:
Positive cash flow shows that cash inflow is higher than outflow during a specific period of time. It means the company has excess cash to re-invest, pay off any debt, pay shareholders etc. However, a positive cash flow doesn’t always mean profit. Other accounting expenses such as depreciation, one-time charges, can lead to a negative net income even if the business clocked in positive cash flows in that same period.
7. Negative cash flow doesn’t necessarily mean loss:
A negative cash flow implies that more cash moved out of the business than came in. Yet, this isn’t a definitive measure of a company incurring a loss. It could be a result of more money being injected into the business itself for growth.
8. Net cash flow balance can be derived from and must equal balance sheet difference in that period:
The cash column under the assets section of a balance sheet for two consecutive periods should have the same difference as the cash flow statement balance in that period. This can be used to verify the accuracy of both statements as well. For example, in the below example for Amazon, the balance sheet difference between “Cash Only” from 2021 to 2020 is 36.48 billion – 42.38 billion, which equals negative 5.9 billion. This is the same as the Net Change in Cash for 2021 in the cash flow statement highlighted in the second figure.
9. Cash flow statements are useful to investors:
By reading and interpreting a cash flow statement, investors can understand if the company has enough cash to meet its expenses. A deeper evaluation of each of the heads under a cash flow statement can help them gauge whether the company is simply low on cash because it has invested in itself or because it is actually not profitable.
10. Cash flow statement must be used in tandem with the income statement and balance sheet:
As we already saw in the case of an indirect cash flow statement, its items are derived from the balance sheet and the income statement. Further, you can match elements of the cash flow statement with those in the other two statements and vice-a-versa. We also saw that the net cash flow does not always reflect profit or loss. Hence, to capture a full picture of a company’s financial health, any analyst, investor, or business owner must use all three statements.
11. Cash flow statement is mandatory to prepare:
Cash flow statement is a financial reporting statement that must be prepared by businesses, as per the Financial Accounting Standards Board (FASB) and International Accounting Standards Board (IAS) requirements.