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Cash Flow Statement In Detail

What Is Cash Flow Statement?

A cash flow statement is a type of financial statement that provides aggregate data regarding all cash inflows that a company receives from its ongoing operations as well as external investment sources. Cash inflows can come from a variety of different sources. In addition to this, it takes into account any and all cash outflows incurred during the specified time period to cover the costs of business activities and investments.


A Cash Flow Statement, which may also be referred to as the Statement of Cash Flows, is a financial document that summarises an organization's cash flows over a specified time period. When building a three-statement model, analysts primarily use the income statement as one of the financial statements to use. The operating activities, investing activities, and financing activities of a company are organised into the three primary categories that make up a cash flow statement. These categories are organised in the following order: (1) operating activities, (2) investing activities, and (3) financing activities.


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Why Cash Flow Statement Important?

The statement of cash flows tells you how much cash went into and out of a company during a particular period of time such as a quarter or a year. You might be wondering why there is a need for such a statement because it sounds very similar to the income statement, which details the amount of money that was spent on expenses in comparison to the amount of money that was brought in from sales.

The difference is based on a complicated idea that's referred to as accrual accounting. The use of accrual accounting requires businesses to record their revenues and expenses at the time the corresponding transactions take place, rather than waiting until cash is actually transferred. Although this explanation may appear to be straightforward, the reality is much more complicated, and the statement of cash flows is what helps investors make sense of it all.


Investors place a high level of importance on a company's statement of cash flows because it reveals the total amount of cash that a business has actually generated. The income statement, and the other hand, often includes non-cash revenues or expenses, which the statement of cash flows excludes.

You should consider a potential investment's ability to generate cash as one of the most important characteristics to look for in that investment. Many companies have shown profits on the income statement but fell later because of insufficient cash flows. A good look at the statement of cash flows for those companies may have warned investors that rough times were ahead.


What is Negative Cash Flow Vs. Positive Cash Flow


A) Negative Cash Flow

A negative cash flow indicates that, during a given time period, your cash expenditures were greater than your cash receipts; however, this does not necessarily mean that you did not make a profit. Instead, a negative cash flow may be caused by a mismatch between the amount of money being spent and the amount of money being brought in. This issue needs to be resolved as soon as possible.

It is important to analyse changes in cash flow from one period to another because these changes can indicate how well a company is performing overall. Negative cash flow may also be caused by a company's decision to expand the business and invest in future growth.


B) Positive Cash Flow

A company is said to have positive cash flow if, over some period of time, the amount of money flowing into the company is greater than the amount of money flowing out of the company. This is the best possible circumstance to be in because having a surplus of cash enables the company to reinvest in itself and its shareholders, settle debt payments, and investigate new avenues through which the company can expand its operations.


The presence of positive cash flow does not, however, guarantee the existence of a profit. Your company may generate a profit even if it does not have a positive cash flow, and conversely, you may have a positive cash flow even if it does not generate a profit.



Direct vs. Indirect Method of Cash Flow Statement

A) Direct Method

The direct method does not begin with the calculation of net income as its starting point; rather, it specifically lists the cash that was received and paid out to third parties throughout the period in question (e.g. cash from customers or cash to suppliers).


B) Indirect Method

When using the indirect method, which is by far the more common approach, the line item that is used as the starting point is the net income. This figure is then adjusted for non-cash items (such as depreciation and amortisation) as well as changes in working capital in order to calculate cash flow from operations.


The Three Elements of the Statement of Cash Flows

The statement of cash flows is broken up into three sections because there are numerous ways in which businesses can acquire cash and put it to use. These sections are: cash flows from operating activities, cash flows from investing activities, and cash flows from financing activities.

Walmart Inc. - Cash Flow Statement Analyst Interview
Walmart Inc. - Cash Flow Statement


Let’s Understand The Important Break Down Of Cash Flow Statement


A- Operating Cash Flow

The Cash Flow from Operating Activities section comes first on the statement of cash flows. The first step is to determine the net income or loss, then adjust that number so that it corresponds to the total cash flow figure. This is done by either adding to or subtracting from the original amount. Changes in the account balances of items that can be found on the balance sheet in the current assets and current liabilities categories, as well as non-cash accounts, are what are added or subtracted in accounting (e.g., stock-based compensation). The next number that we consider is the cash equivalent of a company's net income.


1) Net Income

This figure represents the final total at the bottom of an income statement. A company's profitability over a given time period can be determined by looking at its net income or earnings. It is determined by beginning with total revenues and deducting from those totals both COGS and total expenses, which include depreciation, selling, general, and administrative costs as well as interest and other expenses.


2) Depreciation and Amortization (D&A)

When utilised in a business, a number of assets see a gradual decline in value over time. As a consequence of this, D&A expenses are those that distribute the cost of an asset over the period of time that it will be useful. The term "amortisation" refers to the process of writing down the value of intangible assets such as patents, copyrights, goodwill, and software, whereas "depreciation" refers to the process of writing down the value of tangible assets such as buildings, machinery, and equipment. In the income statement, D&A will result in a lower net income. However, due to the fact that these are non-cash expenditures, we have to add this back into the cash flow statement in order to adjust the net income. In other words, there are no monetary exchanges that take place.


3) Changes in working capital

Difference between a company's current assets and current liabilities is what's meant to be referred to as its "working capital." The cash balance in operating activities is affected by any changes that occur in the current assets (other than cash) and current liabilities.

For instance, an increase in a company's current assets occurs whenever the company purchases additional inventory. Because it is considered an outflow of cash, the positive change in inventory that occurred is deducted from the business's net income. The situation is the same with regard to accounts receivable. If it goes up, that indicates that the company sold more of their products on credit. Due to the absence of a cash transaction, the amount of accounts receivable has been deducted from the business's overall net income.

On the other hand, an increase in a current liability item such as accounts payable is regarded as a cash inflow by the company because it results in the company having more cash available for use in the operation of the business. After that, the total for this is added to the net income.


4) Cash from Operations

After making all of the necessary corrections, we can finally determine the amount of net cash that was generated by the operating activities of the company. This is not a substitute for the company's net income; rather, it is a synopsis of the amount of cash that is generated from the company's primary operations.


In order to Understand Cash Flow From Operating Activities, Here Are Some Important Tips

If balance of an asset Goes UP, cash flow from operations will Goes Down.

If balance of an asset Goes Down, cash flow from operations will Goes UP.

If balance of a liability Goes UP, cash flow from operations will Goes UP.

If balance of a liability Goes Down, cash flow from operations will Goes Down.


B- Investing Cash Flow

This section of the statement of cash flows is referred to as the Cash Flow from Investing Activities and reports any shifts that have occurred in the company's long-term investments or capital expenditures (CapEx). The term "CapEx" can also refer to the acquisition of assets such as property, plant, or equipment. Investing for the long term may involve purchasing debt or equity instruments issued by other companies. Acquisitions of other businesses constitute yet another significant component of this section. One of the most important things to keep in mind is that any change that occurs in the long-term assets section of the balance sheet is reflected in the cash flow statement under the heading "investing activities."


1) Investments in Property and Equipment or Capital Expenditure

These capital expenditures may involve the purchase of new office equipment such as computers and printers to accommodate an increasing number of employees, or they may involve the acquisition of new land and a building to accommodate the company's business operations and logistics. These things are required to ensure that the business continues to function properly. These investments result in a negative cash outflow, and as a result, they will have a negative impact when we calculate the overall net increase in cash that was generated from all activities.


2) Cash Used For Acquisitions

The amount of cash that was spent by one company to acquire another is referred to by the acquisitions line item. It is important to keep an eye on this line item in order to determine how much cash a company is spending on acquisitions. This is due to the fact that businesses have a tendency to overpay for acquisitions. You will also get a good idea, with the help of this line item, of how much of a company's expansion is coming from internal sources as opposed to acquisitions.


3) Cash from investing

This is the total amount of cash that was generated by (put to use in) various forms of investing. In our illustrative example, each and every year demonstrates a negative net cash flow.


C- Financing Cash Flow

This section, which also goes by the name Cash Flow from Financing Activities, is where the company reports any transactions involving the issuance or repurchase of stocks and bonds, as well as any dividend payments that the company may have made. In the balance sheet, the changes that occur in long-term liabilities and stockholders' equity are reported as part of the financing activities section.


1) Issuance (repayment) of debt

The issuance of debt by a company is one method by which it can finance its operations. The more liquid assets it possesses, the better, as this ensures that it can quickly expand its operations. The issuance of debt, as opposed to equity, does not grant any ownership interest in the company; consequently, it does not dilute the ownership of shareholders who are already present. Because a company can find investors willing to act as lenders through the process of issuing debt, this results in an increase in the amount of cash that the company receives. On the other hand, the repayment of the debt constitutes a cash outflow once the investors are paid back.


2) Issuance (repayment) of equity

This is an additional method that can be used to finance the operations of a company. In contrast to holders of debt, investors in equity receive a portion of the company's ownership in exchange for the provision of funds for the company's operations. It is necessary to distribute a portion of future profits to the shareholders or investors in the company. A cash inflow results from the issuance of equity because it creates a new cash source for the company. On the other hand, a repayment of equity results in a loss of cash. This involves making a monetary payment to the investors in order to buy back their equity, which results in an increase in the percentage of ownership that is held by the company itself.


3) Cash from financing

This is something that is also referred to as the net cash that was provided by (used for) financing activities. The cash from financing is determined by adding together all of the cash inflows and outflows that are associated with changes in the accounts for long-term liabilities and shareholders' equity.


D- Cash Balance

A balances of the total cash position is presented as the final section of the statement of cash flows. This section connects to the balance sheet. When it comes to connecting the three financial statements, this is the last missing piece of the puzzle.


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

When we have the net cash balances for all of the cash flow statement's three sections, we can then add them all up to determine whether or not there has been a net increase or decrease in cash during the specified time period. After that, we take this amount and add it to the cash balance at the beginning of the period in order to get to the cash balance at the end of the period. This figure will be included in the section of the balance sheet statement devoted to current assets when it is generated.


Formula

Net Change in Cash = Cash from Operations + Cash from Investing + Cash from Financing

Ending Cash Balance = Beginning Cash Balance + Net Change in Cash


2) Opening cash balance

The cash balance at the end of the previous year will serve as the opening cash balance. Both the cash flow statement and the balance sheet statement from the previous year will provide us with this amount.


What are The Pros and Cons of Cash Flow Statement

A- Pros of Cash Flow Statement

  • Cash Flow Statements are useful for determining the liquidity and actual cash position of a company, which is information that funds flow and profit and loss statements are unable to provide.

  • Due to the fact that the liquidity position is known, any deficits can be compensated for, and any surplus can be put toward the expansion of the company.

  • When comparing the cash positions of both entities, one can use the cash flow statement to get an idea of whether or not there is a discrepancy in the financial reporting.

  • Cash is the foundation on which all other financial operations are built. Therefore, in order for management to effectively plan for and maintain control over the financial operations, a projected cash flow statement will be required.

  • In order to measure a company's profitability and its current financial position, it is helpful to conduct both a Cash Flow analysis and a ratio analysis.

  • The statement of cash flows is helpful in internal financial management because it is used in the process of formulating financial plans.

B- Cons of Cash Flow Statement

  • Since the cash flow statement only details the company's cash position, it is not possible to calculate the actual profit and loss of the business using just that document. It has a narrow application, and by itself it serves no purpose; for projections, it needs both a balance sheet and a profit and loss statement. The statement of cash flows does not include information about the business's net income. Because of this, it cannot serve as an alternative to the income statement.

  • Because of the ease with which it can be influenced, the cash balance that is shown on the cash flow statement may not accurately reflect the real liquidity position of the company. This is due to the fact that the company may choose to delay purchases and other payments.

  • There is no way for the cash flow statement to take the place of the funds flow statement. Both of these things are responsible for executing separate tasks.

Frequently Asked Question (FAQ)

What is a cash flow statement?

A cash flow statement is a financial statement that provides information about the cash inflows and outflows of a company over a specific period. It shows how changes in the balance sheet and income statement affect the cash position.


Why is the cash flow statement important?

The cash flow statement is crucial because it helps assess a company's ability to generate cash, meet its financial obligations, and invest in future growth. It provides insights into the cash flows from operating, investing, and financing activities.


What are the three main sections of a cash flow statement?

The three main sections of a cash flow statement are operating activities, investing activities, and financing activities. These sections report cash flows from different sources.


What are operating activities in a cash flow statement?

Operating activities include cash flows from the company's primary business operations. This includes cash received from customers, cash paid to suppliers and employees, and other operating expenses.


What are investing activities in a cash flow statement?

Investing activities include cash flows related to the acquisition and disposal of long-term assets, such as property, plant, and equipment. It also includes cash flows from investments in securities and loans made to other entities.


What are financing activities in a cash flow statement?

Financing activities include cash flows related to the company's capital structure. This includes cash received from issuing debt or equity, as well as cash paid out as dividends or for debt repayments.


How is the net cash flow from operating activities calculated?

The net cash flow from operating activities is calculated by adjusting the net income for non-cash expenses, changes in working capital, and other items. It shows the actual cash generated or used by the company's core operations.


How is the net cash flow from investing activities calculated?

The net cash flow from investing activities is calculated by summing the cash inflows and outflows related to investing activities. It represents the cash used for acquiring or selling long-term assets and investments.


How is the net cash flow from financing activities calculated?

The net cash flow from financing activities is calculated by summing the cash inflows and outflows related to financing activities. It represents the cash raised or used for capital financing, such as issuing or repaying debt, or issuing or repurchasing equity.


What is the significance of positive and negative cash flows?

Positive cash flows indicate that the company is generating more cash than it is using, which is generally favorable. Negative cash flows indicate that the company is using more cash than it is generating, which may be a cause for concern.


Can a company have positive net income but negative cash flow?

Yes, it is possible for a company to have positive net income but negative cash flow. This situation can occur when there are non-cash expenses, such as depreciation or amortization, which are added back in the cash flow statement.


How does the cash flow statement differ from the income statement?

The cash flow statement focuses on cash inflows and outflows, while the income statement focuses on revenues and expenses. The cash flow statement shows the actual movement of cash, whereas the income statement reflects accrual-based accounting.


What does the cash flow statement reveal about a company's liquidity?

The cash flow statement provides insights into a company's liquidity by showing the sources and uses of cash. It helps assess whether a company has sufficient cash to meet its short-term obligations and fund its operations.


How does the cash flow statement help with financial analysis?

The cash flow statement helps with financial analysis by providing additional information about a company's financial performance and cash management. It allows analysts to evaluate the cash-generating ability of the company's operations, assess its investing and financing activities, and identify potential risks or opportunities.


How can investors use the cash flow statement?

Investors can use the cash flow statement to understand how a company is generating and utilizing its cash. It helps evaluate the company's ability to generate future cash flows, pay dividends, and fund growth. It also provides insights into the company's capital structure and financial health.


How does the cash flow statement help in assessing business sustainability?

The cash flow statement helps assess business sustainability by revealing the company's ability to generate consistent cash flows over time. It provides information on how the company manages its cash resources and whether it can fund its operations and growth in the long run.


Can the cash flow statement be used to detect financial fraud?

Yes, the cash flow statement can be used to detect financial fraud. Unusual or unexpected patterns in cash flows can be indicators of fraudulent activities, such as inflating revenues or manipulating expenses. It is important to analyze the cash flow statement in conjunction with other financial statements for a comprehensive assessment.


How does depreciation affect the cash flow statement?

Depreciation is a non-cash expense that is added back to net income in the operating activities section of the cash flow statement. It does not involve an actual cash outflow but reduces net income, thereby increasing the cash flow from operating activities.


What is the relationship between the cash flow statement and the balance sheet?

The cash flow statement and the balance sheet are interrelated. The cash flow statement explains the changes in the cash balance, which is reflected in the balance sheet. The ending cash balance in the cash flow statement should match the cash amount reported in the balance sheet.


How often is the cash flow statement prepared and reported?

The cash flow statement is typically prepared and reported on a quarterly and annual basis. It is a mandatory financial statement for publicly traded companies and is also important for internal financial reporting purposes.

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