Cash Flow Statement In Detail

Meaning Of Cash Flow

A Cash Flow Statement (also known as the Statement of Cash Flows) is a financial statement that shows how much cash is generated and spent over a specified period of time. It is one of the most important financial statements that financial analysts use when constructing a three-statement model. The following are the major categories that can be found in a cash flow statement:

(1) Operating activities

(2) Investing activities

(3) Financing activities

When the total cash provided by or used by each of the three activities is added together, it results in the total change in cash for the period, which is then added to the opening cash balance to produce the bottom line of the cash flow statement, the closing cash balance.

One of the most important reasons for tracking cash inflows and outflows is to compare cash from operations to net income, which is one of the most common reasons for doing so. This comparison aids company management, analysts, and investors in determining how well a company is managing its operations on a daily basis. The cash flow statement reflects the actual amount of money received by the company as a result of its business operations.

The reason for the discrepancy between cash and profit is that the income statement is prepared using the accrual basis of accounting, which matches revenues and expenses for the accounting period, even though revenues may not have been collected and expenses may not have been paid at the time of the income statement's preparation. The cash flow statement, on the other hand, only records cash that has been received or disbursed in the actual transaction.

Method Of Calculating cash flow

Direct Method

The direct method necessitates more effort and organization than the indirect method because you must generate and keep track of cash receipts for each cash transaction, as opposed to the indirect method. As a result, smaller businesses are more likely to prefer the indirect method.

This should be mentioned as well: If you record cash flows in real time using the direct method, you will still need to use the indirect method in order to reconcile your statement of cash flows to your income statement. As a result, you can expect the direct method to take longer than the indirect method in most situations.

Indirect Method

To calculate working capital using the indirect method, you first look at the transactions that have been recorded on your income statement and then reverse some of them to determine your working capital. You're selectively backtracking your income statement in order to eliminate transactions that don't show any evidence of cash movement in your business.

Many small businesses prefer this method over the direct method because it is more straightforward. Using the indirect method also eliminates the need to go back and reconcile your statements with those obtained through the direct method.

How to Prepare a Statement of Cash Flows

The operating section of the statement of cash flows can be represented using either the direct method or the indirect method of presentation. The investing and financing sections are identical in both methods; the only difference is the operating section, which is different in both methods. The direct method displays the major categories of gross cash receipts and gross cash payments in a straightforward manner.

The indirect method, on the other hand, begins with the net income and adjusts the profit/loss to account for the effects of the transactions as they occur. Finally, cash flows from the operating section will result in the same result regardless of whether the approach is direct or indirect; however, the presentation will differ.

The International Accounting Standards Board (IASB) prefers the direct method of reporting over the indirect method of reporting because it provides more useful information than the latter. However, it is estimated that the indirect method is used by more than 90 percent of publicly traded corporations.

Classification of Cash Flow Statement

Cash Flows From Operations (CFO)

Alternatively known as operating cash flow, cash flow from operations (CFO) refers to money flows that are directly associated with the production and sale of goods from ordinary operations. The Chief Financial Officer (CFO) determines whether or not a company has enough funds coming in to pay its bills or cover its operating expenses. In other words, a company's operating cash inflows must exceed its operating cash outflows in order for it to be financially viable over the long term.

In order to calculate operating cash flow, take the cash received from sales and subtract the operating expenses that were paid in cash during the period in question. On a company's cash flow statement, which is reported on a quarterly and annual basis, operating cash flow is recorded in the form of dollars. When a company's operating cash flow is sufficient to maintain and expand operations, it can be used to determine whether the company will require external financing to fund capital expansion.

It should be noted that the CFO is useful in distinguishing between sales and cash received. If, for example, a company receives a large order from a customer, the company's revenue and earnings would increase. However, if the company is having difficulty collecting payment from the customer, the additional revenue will not necessarily result in improved cash flow.

Net Earnings:

This is the amount that appears at the bottom of a Income statement. The profitability of a company over a period of time is represented by its net income or earnings. When you take total revenues and subtract from them the cost of goods sold and total expenses, which includes SG&A, depreciation and amortization, interest and other expenses, you get a net profit.

Depreciation and Amortization (D&A)

When assets are used in a business, the value of those assets decreases over time. As a result, depreciation and amortization (D&A) are expenses that spread the cost of an asset over its useful life. Depreciation is used to account for tangible assets such as buildings, machinery, and equipment, whereas amortization is used to account for intangible assets such as patents, copyrights, goodwill, and computer software. Depreciation and amortization (D&A) decrease net income on the income statement. Due to the fact that these are non-cash expenses, we must include them in the cash flow statement in order to adjust the net income. In other words, there are no cash transactions taking place.

Working Capital

It is the difference between a company's current assets and current liabilities that is referred to as working capital. In operating activities, changes in current assets (other than cash) and current liabilities have an impact on the cash balance due to changes in current assets and current liabilities.

For example, when a company purchases more inventory, the amount of current assets increases. Because it is regarded as a cash outflow, the positive change in inventory is deducted from net income to arrive at the net income figure. The same can be said for accounts receivable (AR). When it rises, it indicates that the company sold their goods on credit to customers. Due to the lack of a cash transaction, accounts receivable are also deducted from the net income figure.

The opposite is true if a current liability item such as accounts payable increases, in which case it is regarded as a cash inflow because the company now has more cash to invest back into the business. This is then included in the net income calculation.

Cash From Operations

After all of the adjustments have been made, we are left with the amount of net cash generated by the company's operating operations. This is not intended to be a substitute for net income, but rather a summary of how much cash is generated by the company's primary operations.

Cash Flows From Investing (CFI)

Cash flow from investing (CFI), also known as investing cash flow, is a financial statement that shows how much money has been generated or spent from various investment-related activities over a given period of time. Aspects of investing activities include the acquisition of speculative assets, the placement of bets on stocks, and the sale of securities or other assets.

Having negative cash flow from investing activities is not always a warning sign, as it could be due to significant amounts of cash being invested in the long-term health of the company, such as in research and development (R&D).

Investments in Property and Equipment

In addition to the purchase of new office equipment such as computers and printers for a growing number of employees, these CapEx investments may also include the acquisition of new land and the construction of a building to house the company's business operations and logistics. These items are required in order for the business to function properly. All of these investments represent a cash outflow, and their impact on the net increase in cash from all activities will be negative when we calculate the net increase in cash from all activities.

Cash from Investing

This is the total amount of money generated by (and used in) investment activities. We have a net outflow for each and every year in our example.

Cash Flows From Financing (CFF)

Cash flows from financing (CFF), also known as financing cash flow, is a financial statement that displays the net cash flows that are used to fund the company and its capital. Among the financing activities are the issuance of debt, the creation of equity, and the payment of dividends. A company's financial strength and the management of its capital structure can be determined by looking at the cash flow generated by its financing activities, which provides investors with valuable information.

Issuance or (repayment) of debt

It is common for businesses to take on debt in order to finance their operations. This is due to the fact that it will be able to expand more quickly the more cash it has on hand. Since issuing debt does not result in the transfer of any ownership interest in the company, it does not dilute the ownership interests of existing shareholders, unlike issuing equity. The issuance of debt results in a cash inflow for the company because it finds investors who are willing to act as lenders. When these investors are repaid, however, the debt repayment becomes a cash outflow, as shown in the chart below.

Issuance or (repayment) of equity

Another method of financing a company's operations is through debt financing. In contrast to debt holders, equity holders receive a portion of the company's equity in exchange for money that is given to the company for use. It is necessary to distribute future earnings to these equity holders or investors. The issuance of equity represents an additional source of cash, and as a result, it represents a cash inflow. An equity repayment, on the other hand, is a cash outflow. This involves the company purchasing back equity from its investors in exchange for cash, thereby increasing the amount of equity held by the company itself.

Cash From Financing

Alternatively, this is referred to as net cash provided by (and used in) financing activities. The cash flow from financing is calculated by adding together all of the cash inflows and outflows associated with changes in long-term liabilities and shareholders' equity accounts over the course of the financial year.

Cash Balance

There is a reconciliation of the total cash position in the last section of the statement of cash flows, which connects to the balance sheet at the end of the document.

Net Increase or (decrease) in Cash and Closing Cash Balance

Once we have all of the net cash balances for each of the three sections of the cash flow statement, we can add them all together to find the net cash increase or decrease for the given time period in the cash flow statement. Then we take this amount and add it to the opening cash balance in order to arrive at the closing cash balance, which is the final figure. This amount will be included in the balance sheet statement's current asset section, which will be reported in the income statement.

Opening cash balance

The opening cash balance is the same as the closing cash balance from the previous year. This amount can be found in the cash flow statement and balance sheet statement from the previous year.

What Can the Statement of Cash Flows Tell Us?

In order to determine the quality of earnings, the cash from operating activities can be compared to the net income of the organization. In the case of earnings that are of "high quality," cash from operating activities exceeds net income by a significant margin.

Assuming that cash is king, this statement is useful to investors because it provides a broad overview of the company's cash inflow and outflow patterns, as well as a broad understanding of the company's overall performance.

The statement of cash flows will quickly reveal whether a company is funding losses from operations or financing investments by raising money (either through debt or equity).