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Cash Flow Statement

The statement of cash flows reports cash inflows and outflows during a period of time, bridging the income statement and balance sheet. It has three sections: operating activities from revenue generation, investing activities from long-term asset changes, and financing activities from equity/debt changes. The statement explains why cash flow differs from net income through non-cash expenses and reconciles the beginning and ending cash balances.

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MUHAMMAD UMAR
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397 views

Cash Flow Statement

The statement of cash flows reports cash inflows and outflows during a period of time, bridging the income statement and balance sheet. It has three sections: operating activities from revenue generation, investing activities from long-term asset changes, and financing activities from equity/debt changes. The statement explains why cash flow differs from net income through non-cash expenses and reconciles the beginning and ending cash balances.

Uploaded by

MUHAMMAD UMAR
Copyright
© © All Rights Reserved
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
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What is the Statement of Cash Flows?

The Statement of Cash Flows (also referred to as the cash flow statement) is


one of the three key financial statements that report the cash generated and
spent during a specific period of time (e.g., a month, quarter, or year). The
statement of cash flows acts as a bridge between the income
statement and balance sheet by showing how money moved in and out of the
business.

What is the Statement of Cash Flows?

The Statement of Cash Flows (also referred to as the cash flow statement) is


one of the three key financial statements that report the cash generated and
spent during a specific period of time (e.g., a month, quarter, or year). The
statement of cash flows acts as a bridge between the income
statement and balance sheet by showing how money moved in and out of the
business.

Three Sections of the Statement of Cash Flows:

1. Operating Activities: The principal revenue-generating activities of an


organization and other activities that are not investing or financing; any
cash flows from current assets and current liabilities
2. Investing Activities: Any cash flows from the acquisition and disposal
of long-term assets and other investments not included in cash
equivalents
3. Financing Activities: Any cash flows that result in changes in the size
and composition of the contributed equity capital or borrowings of the
entity (i.e., bonds, stock, dividends)
 

Cash Flow Definitions

Cash Flow: Inflows and outflows of cash and cash equivalents (learn more in
CFI’s Ultimate Cash Flow Guide)

Cash Balance: Cash on hand and demand deposits (cash balance on


the balance sheet)

Cash Equivalents: Cash equivalents include cash held as bank deposits, short-


term investments, and any very easily cash-convertible assets – includes
overdrafts and cash equivalents with short-term maturities (less than three
months).

Cash Flow Classifications

1. Operating Cash Flow

Operating activities are the principal revenue-producing activities of the


entity. Cash Flow from Operations typically includes the cash flows associated
with sales, purchases, and other expenses.

The company’s chief financial officer (CFO) chooses between the direct and


indirect presentation of operating cash flow:

 Direct Presentation: Operating cash flows are presented as a list of


cash flows; cash in from sales, cash out for capital expenditures, etc. This
is a simple but rarely used method, as the indirect presentation is more
common.
 Indirect Presentation: Operating cash flows are presented as a
reconciliation from profit to cash flow:

 
The items in the cash flow statement are not all actual cash flows, but “reasons
why cash flow is different from profit.”

Depreciation expense reduces profit but does not impact cash flow (it is
a non-cash expense). Hence, it is added back. Similarly, if the starting point
profit is above interest and tax in the income statement, then interest and tax
cash flows will need to be deducted if they are to be treated as operating cash
flows.

There is no specific guidance on which profit amount should be used in the


reconciliation. Different companies use operating profit, profit before tax,
profit after tax, or net income.  Clearly, the exact starting point for the
reconciliation will determine the exact adjustments made to get down to an
operating cash flow number.

2. Investing Cash Flow

Cash Flow from Investing Activities includes the acquisition and disposal of


non-current assets and other investments not included in cash equivalents.
Investing cash flows typically include the cash flows associated with buying or
selling property, plant, and equipment (PP&E), other non-current assets, and
other financial assets.

3. Financing Cash Flow

Cash Flow from Financing Activities are activities that result in changes in the
size and composition of the equity capital or borrowings of the entity.
Financing cash flows typically include cash flows associated with borrowing
and repaying bank loans, and issuing and buying back shares. The payment of
a dividend is also treated as a financing cash flow.

Statement of Cash Flows Example

Below is an example from Amazon’s 2017 annual report, which breaks down
the cash flow generated from operations, investing, and financing activities.
Learn how to analyze Amazon’s consolidated statement of cash flows in
CFI’s Amazon Advanced Financial Modeling Course.
 
Source: amazon.com
Image: Course in CFI’s Financial Analyst Training Program.

Interest and Cash Flow

Under IFRS, there are two allowable ways of presenting interest expense in the
cash flow statement. Many companies present both the interest received and
interest paid as operating cash flows. Others treat interest received
as investing cash flow and interest paid as a financing cash flow. The method
used is the choice of the finance director.

Under U.S. GAAP, interest paid and received are always treated as operating
cash flows.

Free Cash Flow

Investment bankers and finance professionals use different cash flow


measures for different purposes. Free cash flow is a common measure used
typically for DCF valuation. However, free cash flow has no definitive definition
and can be calculated and used in different ways.

How to Prepare a Statement of Cash Flows?

The operating section of the statement of cash flows can be shown through
either the direct method or the indirect method. With either method, the
investing and financing sections are identical; the only difference is in the
operating section. The direct method shows the major classes of gross cash
receipts and gross cash payments. The indirect method, on the other hand,
starts with the net income and adjusts the profit/loss by the effects of the
transactions. In the end, cash flows from the operating section will give the
same result whether under the direct or indirect approach, however, the
presentation will differ.

The International Accounting Standards Board (IASB) favors the direct method


of reporting because it provides more useful information than the indirect
method. However, it is believed that greater than 90% of companies use the
indirect method.

Direct Method vs Indirect Method of Presentation

There are two methods of producing a statement of cash flows, the direct
method, and the indirect method.

In the direct method, all individual instances of cash that is received or paid


out are tallied up and the total is the resulting cash flow.

In the indirect method, the accounting line items such as net income,
depreciation, etc. are used to arrive at cash flow.  In financial modeling, the
cash flow statement is always produced via the indirect method.

Below is a comparison of the direct method vs the indirect method.

Below is a comparison of the direct method vs the indirect method.

 
 

What Can the Statement of Cash Flows Tell Us?

 Cash from operating activities can be compared to the company’s net


income to determine the quality of earnings. If cash from operating
activities is higher than net income, earnings are said to be of “high
quality.”
 This statement is useful to investors because, under the notion that cash
is king, it allows investors to get an overall sense of the company’s cash
inflows and outflows and obtain a general understanding of its overall
performance.
 If a company is funding losses from operations or financing investments
by raising money (debt or equity) it will quickly become clear on the
statement of cash flows
Linkages of the Cash Flow Statement with the Income
Statement and the Balance Sheet
The important linkages between the cash flow statement, income statement, and the
balance sheet include the following:

 The beginning and ending balance sheet amounts of cash and cash equivalents
are linked through the cash flow statement. Specifically, the statement of cash flows
shows the change in the cash balance during the reporting period, according to the
following equation:

Beginning cash balance + Cash receipts from operating, investing and financing
activities – Cash payments for operating, investing, and financing activities = Ending
cash balance

 The current assets and current liabilities sections of the balance sheet typically
reflect a company’s operating decisions and activities. Any differences between the
accrual basis and cash basis of accounting for an operating transaction will result in an
increase or decrease in a short-term asset or liability on the balance sheet.

 The investing activities of a company usually relate to the long-term asset


section of the balance sheet, while its financing activities usually relate to the equity
and long-term debt sections of the balance sheet.

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