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What Is a Cash Flow Statement?

The cash flow statement, or statement of cash flows, is one of the three main financial reports. Unlike the balance sheet, which shows what a company owes and owns, or an income statement which shows how profitable a business was during a specific period, the cash flow statement shows how cash and cash equivalents flow in and out of a business.

This report is important for business managers and investors as it shows how efficiently a business is managing their cash. Understanding how to read the statement of cash flows is unquestionably important. 

How Does a Statement of Cash Flows Work?

This statement serves as an electronic log of all the money entering and leaving a business. A finance or accounting team will assemble the cash flow statement as they record income and expenses throughout the month, quarter, or aggregate it for the entire year.

A cash flow is effectively a businesses checkbook. The same way you may balance your expenses each month and figure out if you have enough cash to cover certain expenses, a business will engage in a very similar process, although more complex. 

What Is the Main Purpose of a Cash Flow Statement?

The main purpose of a cash flow statement is to provide insight as to how the business is gaining or losing cash over a period of time. The cash flow statement tracks any deposits a business had along with any expenses.

What Does a Cash Flow Statement Tell You?

Simply put, this report tells the management team and investors how liquid the business is, and how effectively they are managing their cash position. These two answers will fuel business decisions and considerations.

Examples of considerations one may pull from the statement of cash flow may include; does the business have enough cash reserves to cover 3 months of operating expenses? Does the business have enough money to purchase an investment? How will the business pay for a specific expense? 

Is Cash Flow the Same as Profit?

Cash flow is not the same as profit. In fact, there could be a dramatic difference between the two. For example, imagine a company purchases a $100,000 piece of equipment in January. They paid cash for this piece of equipment, but decided to depreciate this asset over a 4 year life cycle. Instead of recognizing a $100,000 expense on January’s income statement, the business will recognize $2,083 for the next 48 months. 

The statement of cash flow will show $100,000 of cash leaving the business in January to purchase the equipment. In each subsequent month, the business will recognize a non-cash expense of $2,083. This expense will erode profitability for the next 47 months, although no additional cash is leaving the business. 

What Is a Good Cash Flow?

Good cash flow is not easily defined. This is subject to many different variables, including: the type of business, the industry, and the carrying costs of the business. If company A and B are competitors, one will want to compare how much cash company A and B are generating. If company A is generating cash twice as quickly as company B, one may question why company B isn’t generating or retaining as much cash. 

The answer could highlight inefficiencies within company B. Perhaps the business is not making the right investments to properly scale and grow the business.

A good rule of thumb is to ensure a business has enough cash to cover X amount of months of operating expenses. That amount is typically between 3 and 6 months as a minimum. 

Does the Cash Flow Have to Balance?

Absolutely, the cash flow statement must balance with the cash position on the balance sheet. 

Where to Find the Statement of Cash Flows

All publicly traded companies need to publish their financial statements online. There are various websites that have this information. Some sites require a subscription, but there are plenty of free, and accurate, sources. For example, www.finance.yahoo.com is a fantastic option! 

Simply enter the company’s ticker symbol, click the Financials Tab and select the “Cash Flow” report. 

What Are the Key Features of a Cash Flow Statement?

The cash flow statement is broken down into three main sections. 

Operating Activities

Cash flow from operating activities highlights the cash used and generated from its normal operations. For example, imagine a business that sells sneakers out of a retail store. The core business is selling sneakers, so the operating cash flow will be the cash used to purchase inventory (sneakers) and the income received from selling the sneakers to customers. 

Investing Activities

The cash flow from investing activities shows how much cash was used to purchase an income producing asset. It will also show the cash flow the business received from previously purchasing an income producing asset, such as another business. 

Financing Activities

Last but not least, the cash flow statement will show the cash flows from financing activities. This category will highlight the cash flow between a business, the investors, the creditors, and the owners. This section includes dividend payments, equity, and debt

How to Read the Statement of Cash Flows

The easiest way to read the cash flow statement is from the top to bottom. First, grab your net income figure from the income statement

Now make your way down the statement of cash flows and see where the company is receiving and spending cash. 

Be aware of red flags. For example, a major red flag that you’ll want to watch out for is if the cash from operating activities is less than the net income figure. If it is in fact less than net income, drill down on that and try to figure out why. Where was money spent in operating activities that eroded the money from net income? 

The last line on the cash flow statement is the ‘net change in cash’. This will highlight if your cash position has either increased or decreased. 

Advantages & Disadvantages of Cash Flow Statements

Let’s cover the advantages and disadvantages of the cash flow statement. 

Advantages of Cash Flow Statements

  • The cash flow statement will show the management team if they can afford certain purchases for their business, or if they need to raise debt in order to pay for the expenses. 
  • The cash flow statement will also show a management team and investor if the business can handle a down month or quarter, as you can get visibility into the cash reserves a business has. 
  • Additionally, the cash flow statement shows how efficiently the business manages its money, and how quickly they generate cash. 

Disadvantages of Cash Flow Statements

  • The cash flow does not split out the net income from operations, so it simply cannot replace a P&L or be viewed in isolation. 
  • The cash position can be inflated if a company postpones payment of certain liabilities. A company may also wish to accelerate paying a bill if there was a financial incentive to do so, such as a discount. More cash will be kept in the business long term, even if it depleted some cash in the short term. 
  • The cash flow statement is specific to a period of time, and does not forecast the future cash expenses or investments of a business. 

Cash Flow Statement vs Balance Sheet

The cash flow statement highlights cash and cash equivalents flowing in and out of the business. A balance sheet highlights what the company owns (assets) and what the company owes (liabilities). 

There are times where a business takes on debt from an investor. That debt will live on both the balance sheet and cash flow statement. Cash is also an asset, and assets get recorded on the balance sheet. 

Cash is King

As the saying goes, cash is king! The statement of cash flows will show you how well a business is managing their cash, and what the company is spending their cash on. Although the statement of cash flows is similar to a personal checkbook, there is a great deal of complexity layered into the financial report. 

Unpacking this complexity, and layering in various ratio analysis, can be tricky if you do not have a finance or accounting background. Working with a professional financial advisor is a great way to ensure you’re investing in companies that fit your risk tolerance.

Financial advisors will help you navigate these complexities and will create a personal financial plan for you and your family. Don’t be afraid to leave the hard stuff to the pros!