What is Cash flow Statement?

Cash flow statement is a statement reported by Corporates in their filings along with the Income Statement and the Balance Sheet. It is very important to understand the Cash flow statement but is often overlooked by investors and analysts.

While the income statement provides the details of income, expenses and net profit earned during a particular time period and the balance sheet of the financial position of the company at a certain point in time. The Cash flow statement shows how efficiently the company is managing its cash. How much cash came in the business during a time period and how much of it was expensed.

Cash flows are not equal to the net profit earned from the business.

There is a difference between cash accounting and accrual accounting. Companies usually follow accrual accounting method to recognize revenues and expenses. In accrual accounting, revenue is recognized when it is earned and expenses are recognized when it is incurred.

Earned revenue may not result in immediate cash inflows as products or services may be sold on credit to customers. Similarly, expenses incurred may not result in immediate cash outflows as corporates usually pay for expenses to the vendors after a certain time (30-90 days credit period).

Also, the income statement includes non-cash income/expenses which does not form part of the cash flow statement

This is the reason why net profit earned in the business is usually not equal to cash flows during that period. It is therefore important to analyze the cash flow statement to understand the cash position of the business.

Types of cash flows

A Cash flow statement has 3 parts;

• Cash flows from operating activities (CFO)
• Cash flows from investing activities (CFI)
• Cash flows from financing activities (CFF)

Let us understand each of them one by one.

Cash flow from operating activities/ Cash flow from operations

This is the most important portion of the cash flow statement. It shows how much cash flows the company is able to generate from its business operations. This section explains the sources and uses of cash from day to day activities during a particular time period. Ongoing activities may include manufacturing and selling products or providing services to customers, payment for purchases, employee salaries, taxes and other operating expenses.

Cash flow from operations can be prepared by two methods.

• Direct Method
• Indirect Method

Both the methods give the same result (ie; cash flow from operations).

Direct method includes.

• Cash sales
• Add: Payment received from customers
• Less: Payment made to vendors
• Less: Payment made for expenses, taxes etc.

This is more intuitive compared to the indirect method. However, it takes more time to prepare a cash flow from operations statement using Direct Method.

Indirect method includes the following.

• Net Income
• Add: Depreciation and Amortization
• Add/ Less: Interest paid/ Interest received (as these are not related to ongoing operating activities)
• Add/Less: Changes in Working capital (Increase in working capital is a cash outflow and vice versa)

Preparing CFO by this method easy compared to the Direct Method. Companies usually prepare this statement using indirect method.

Cash flow from investing activities

This shows the cash spent by the company in investments made for future growth. The investment could be in property plant and equipment or acquisition of other businesses or investments in securities of other Companies. Cash flow from investing activity is generally negative as it is a cash outflow.

However, if a company sells its assets or investments during a particular period, the cash flow from investing activities can be positive.

Cash flow from financing activities

This section summarizes transactions that involve raising or repayment of capital. Raising capital could be done by issuance of new shares or borrowing through debt financing. Repayment includes, repayment of debt or share repurchases. This also includes interest payments to debt financiers and payment of dividends to shareholders.

At the bottom of the cash flow statement, we have the cash reconciliation. It shows opening cash balance and the ending cash. The difference between the two should be equal to the net cash inflow or outflow from the three cash flow activities described above.

In other words,

Cash balance at the beginning of the period

+/- Cash flows from operating activities

+/- Cash flows from investing activities

= Cash balance at the end of the period

Typically, as a Financial Analyst, we need to periodically assess the cash flows statements of a company through financial modelling in Excel exercise. It will require detailed assessment of financial analytics of a company both for historical as well as future years.

Let us look at an example. Here we have a cash flow statement of “Alphabet Inc.”

Cash flow from Operating activities, Cash flow from Investing Activities and Cash flow from Financing activities have been highlighted below.

Now let us review each of the activities one by one.

Cash flow from operating activities

The cash flow from operating activities above is prepared using indirect method.

It starts with the Net income reported during the period. The Company then adds all the non-cash expenses like Depreciation and amortization, impairment and stock-based compensation. Gain/loss on debt / equity securities is deducted as it is not an income from business operations of the Company. Post that the Company adjusts changes in working capital.

Check out online financial modelling course in Excel.

Accounts receivable increased during the year that is why it is a negative in the cash flow statement as these receivables did not translate to cash flows for the company. Similarly accounts payable and accrued expenses also increased during the period therefore they are shown as a positive in the cash flow statement as they did not result in cash outflow for the Company.

This statement shows that “Alphabet Inc.” has generated $54,520 million cash during the financial year 2019.

Cash flow from investing activities

Cash flow from investing activities includes capex investment for future growth, Purchase and sale of investments and cash outflow on acquisitions.

Cash flow from financing activities

This includes payment to shareholders in the form of share repurchases, stock options and issuance and repayment of borrowings.

At the end of the cash flow statement, we have the Cash reconciliation.

Net increase/decrease in cash and cash equivalents is the sum of all the three cash flow activities plus effect of foreign exchange rate changes.

It shows that cash balance for Alphabet Inc. increased by $1,797 million in 2019.

Below it we have the cash and cash equivalents at the beginning and end of the period. Ending cash balance for Alphabet is $18,498 million which should be equal to what is reported in the closing balance sheet for the period.

Here is the screen shot from the cash flow statement and balance sheet.

To become an expert in financial analysis and modeling techniques, you need to master the skills through Financial Analyst courses.

Good luck, keep learning!!

P.S. You will need to log in to drop your comments.