Cash Flow Statements: Meaning, Components, Examples and Importance

The Meaning of a Cash Flow Statement

A cash flow statement is a financial statement that shows the inflows and outflows of cash and cash equivalents during a specific period of time. It provides information about how cash is generated and used by a company, which is important for understanding its financial health and ability to meet its financial obligations.

Components of a Cash Flow Statement

The cash flow statement is divided into three sections: operating activities, investing activities, and financing activities.

  • Operating activities: This section shows the cash inflows and outflows from the company’s main business activities, such as sales and purchases of inventory, payment of salaries and wages, and payment of taxes. Items in operating activities section of a cash flow statement may include:
    • Net income
    • Adjustments to reconcile net income to cash generated by operating activities:
      • Depreciation and amortization
      • Deferred income tax expense
      • Others
    • Accounts receivable
    • Inventories
    • Other current and non-current assets
    • Accounts payable
    • Deferred revenue
    • Other current and non-current liabilities
  • Investing activities: This section shows the cash inflows and outflows from the company’s investments in long-term assets, such as property, plant, and equipment, and other investments. Items in the investing activities section include:
    • Purchases of marketable securities
    • Proceeds from maturities of marketable securities
    • Proceeds from sales of marketable securities
    • Cash spent in business acquisitions
    • Cash use for acquisition of property, plant and equipment (PPE)
    • Payments for the acquisition of intangible assets
  • Financing activities: This section shows the cash inflows and outflows from the company’s financing activities, such as issuing or repaying debt, issuing or repurchasing stock, and paying dividends. Items in financing activities section include:
    • Payment of dividends and rights
    • Repurchase of common stock
    • Proceeds from issuance of long term debt
    • Others

This list is not exhaustive. You have to figure out which components in a particular company can generate or spend cash in the form of operating, investing, and financing activities.

Methods of Preparing/Calculating a Cash Flow Statement

A cash flow statement can be calculated and prepared in two primary ways: method and indirect method.

1) Direct Method

The direct method of calculating a cash flow statement involves the use of all transactional information that affect cash during a specific period. To prepare a cash flow statement using the direct method, you are required to add all cash collected from operating activities and subtract all the cash dispensed from operating activities.

2) Indirect Method

Another method of preparing a cash flow statement is the indirect method, which uses the accrual accounting method to record accounting transactions such as revenues and expenses – as opposed to when cash was paid or received. These accrual entries and adjustments will cause a discrepancy between the cash flow from operating activities and net income. Instead of organizing transactional data like the direct method, the accountant starts with the net income number found from the income statement and makes adjustments to undo the impact of the accruals that were made during the period.

Interpretation of a Cash Flow Statement

The net increase or decrease in cash and cash equivalents for the period is shown at the bottom of the statement. A positive number indicates that the company generated more cash than it used during the period, while a negative number indicates that the company used more cash than it generated.

Positive Cash Flow

When the cash flow statement indicates a positive cash flow, it means that the company is receiving more cash than it is spending. More cash are coming while less money is going out. A positive cash flow is ideal for any company because it ensures that the company has enough cash to pay its liabilities, run operations, invest in projects, and pay dividends.

Negative Cash Flow

A negative cash flow occurs when a company’s cash outflows exceed its cash inflows. A negative cash flow may reflect higher expenditures than income. It may also be caused by a company’s decision to invest in a particular project such as purchasing an asset for future growth. Having a negative cash flow does not necessarily mean a bad situation because the company may forego immediate cash flow to invest in a project that will generate more income in the future.

Example of a Cash Flow Statement

Company A – Statement of Cash Flows (Alternative Version)

Year Ended September 28, 2019 (In millions)

Cash and cash equivalents, beginning of the year: $10,746

OPERATING ACTIVITIES

Activity Amount
Net Income 37,037
Adjustments To Reconcile Net Income To Cash Generated By Operating Activities:
Depreciation And Amortization 6,757
Deferred Income Tax Expense 1,141
Other 2,253
Changes In Operating Assets And Liabilities:
Accounts Receivable, Net (2,172)
Inventories (973)
Vendor Non-Trade Receivables 223
Other Current And Non-Current Assets 1,080
Accounts Payable 2,340
Deferred Revenue 1,459
Other Current And Non-Current Liabilities 4,521
Cash Generated By Operating Activities 53,666

 

INVESTING ACTIVITIES

Activity Amount
Purchases Of Marketable Securities (148,489)
Proceeds From Maturities Of Marketable Securities 20,317
Proceeds From Sales Of Marketable Securities 104,130
Payments Made In Connection With Business Acquisitions, Net Of Cash Acquired (496)
Payments For Acquisition Of Intangible Assets (911)
Other (160)
Cash Used In Investing Activities (33,774)

FINANCING ACTIVITIES

Activity Amount
Dividends And Dividend Equivalent Rights Paid (10,564)
Repurchase Of Common Stock (22,860)
Proceeds From Issuance Of Long-Term Debt, Net 16,896
Other 149
Cash Used In Financing Activities (16,379)

Increase / Decrease in Cash and Cash Equivalents: 3,513

Cash and Cash Equivalents, End of Year: $14,259

From the figure above, the fictional company started with cash of $10.75 billion. The company’s cash flows are then broken down into cash from operating activities, investing activities, and financing activities. The operating activities brought net cash flows of $53.66 while cash spent in investing activities amounted to $33.77 billion. Lastly, the company recorded cash outflows from financing activities of $16.3 billion. As a result, the company ended up with a positive cash flow of $3.5 billion, which shows an increase in cash and cash equivalents within the review period. This can be added to the opening cash to arrive at the total end year cash of $14.26 billion. The positive cash flow indicates that the company has enough cash to pay its financial obligations and invest for future growth. A significant amount of cash in the company was generated from operating activities, showing that the company’s operations are efficient.

Importance of a Cash Flow Statement

The cash flow statement is important for investors, creditors, and analysts because it provides information about a company’s ability to generate cash, pay its debts, and invest in its business. By analyzing the cash flow statement, investors and analysts can assess the quality of a company’s earnings and make informed decisions about whether to invest in or lend money to a company.

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