What Is a Cash Flow Statement (And How to Prepare It)

One of the three essential financial statements business leaders employ is the cash flow statement. Cash flow statements, together with income statements and balance sheets, offer critical financial information that supports organizational decision-making. Although all three are crucial for analyzing a company's finances, some business executives could contend cash flow statements are the most critical.

Here's everything you need to know about cash flow statements, including what they are and how to prepare them.

What is a Cash Flow Statement?

A cash flow statement is a type of financial statement that gives comprehensive information about all the cash inflows a business makes from continuing activities and outside investment sources. It also includes any cash outflows made within a specific time period to cover investments and business expenses.

A firm's financial statements give investors and analysts a picture of all the business transactions that take place, where each transaction helps the company succeed. Because it tracks the cash generated by the business in three key ways—through operations, investments, and financing—the cash flow statement is seen to be the most understandable of all the financial statements. Net cash flow is the total of these three components.

Investors can estimate the worth of a company's stock or the business overall using these three components of the cash flow statement.

How Is the Cash Flow Statement used?

The cash flow statement (CFS) outlines a company's cash and cash equivalents (CCE) inflow and outflow. We'll show you how it's used and structured below.

Structure of the Cash Flow Statement

The following are the key elements of the cash flow statement:

1. 1. Cash Flow from operating activities
2. 2. Cash flow from investing activities
3. 3. Cash flow from financing activities

1. Cash Flow from operating activities

Any sources and uses of money from commercial operations are included in the operating activities on the CFS. In other words, it shows how much money a company makes from its goods or services.

These operational activities could consist of:

• Payments received from the sale of products and services
• Interest charges
• Payment of income taxes
• Payments made to vendors of the supplies and labor employed in manufacturing
• Payments of wages and salaries to employees
• Rent obligations
• Any additional operational costs

2. Cash Flow from investing activities

Any sources and applications of funds from a company's investments are considered investing activities. This category includes any payments made in connection with mergers and acquisitions (M&A) as well as asset purchases or sales, vendor or customer loans, and any other payments. In other words, changes to investments, equipment, or assets are related to cash from investments.

Because cash is used to purchase new machinery, structures, or transient assets like marketable securities, changes in cash from investments are typically seen as cash-out items. However, for the purposes of determining cash from investment, a company's asset divestiture is treated as a cash-in transaction.

3. Cash Flow from financing activities

The sources of cash from banks and investors, as well as the methods of paying out cash to shareholders, are all included in the cash from financing operations. This includes any dividends, stock repurchase payments, and the corporation's principal loan repayments.

Cash from financing changes as capital is raised, and cash from financing exits when dividends are paid. So, if a business offers a bond to the general public, it gets cash financing. However, the company's cash is reduced when interest is paid to bondholders. Also, keep in mind that although interest is a cash-out item, it is recorded as an operating activity rather than a financing activity.

How is Cash Flow calculated?

The direct method totals all financial outlays and inflows, including cash paid to vendors, cash collected from clients, and cash received as salaries. This CFS method is simpler for relatively small enterprises that employ the cash basis of accounting.

These figures can also be computed by comparing the net gain or reduction in the various asset and liability accounts' beginning and ending balances. It is provided in an uncomplicated way.

When using the indirect technique, differences from non-cash transactions are added or subtracted from net income before calculating cash flow. Non-cash items can be seen in the shifts in a company's assets and liabilities from one period to the next on its balance sheet. To determine an accurate cash inflow or outflow, the accountant will identify any increases and decreases in asset and liability accounts that need to be added back to or subtracted from the net income figure.

Cash flow must reflect changes in accounts receivable (AR) from one accounting period to the next on the balance sheet:

• If AR declines, additional money may have come into the business from consumers paying off their credit cards; the difference between the AR decline and net earnings is then added.
• Although the amounts reflected in AR are revenue, they are not cash, so an increase in AR must be subtracted from net earnings.

What about adjustments to a business's inventory? They are recorded in the CFS in the following ways:

• A rise in inventory indicates a company's increased expenditure on raw materials. Using cash entails deducting the increase in inventory value from net profits.
• Net earnings would increase if inventories decreased. Accounts payable on the balance sheet are increased as a result of credit purchases, and the difference between the two years' worth of increases is added to net income.

The same reasoning applies to unpaid taxes, wages, and pre-paid insurance. The difference in the amount due from one year to the next after something has been paid off must be deducted from net income. Any discrepancies must be added to net earnings if a balance is still outstanding.

Now that we know how the cash flow statement is used let's look at an example.

Cash Flow Statement Example

Here is an example of a hypothetical company that created a CFS using the indirect technique to help you visualize each area of the cash flow statement.

The reporting period for this cash flow statement ended on September 28, 2019. The initial balance of cash and cash equivalents was around $10.7 billion, as you can see at the top of the statement.

Operating activities produced a total of $53.7 billion during the reporting period. According to the section on investing operations, the business used $33.8 billion in transactions relating to investments. According to the financing activities section, debt and equity financing-related activities cost a total of $16.3 billion.

The three sections are added together at the bottom of the cash flow statement to represent an increase in cash and cash equivalents of $3.5 billion during the course of the reporting period. As a result, $14.3 billion is the total amount of cash and cash equivalents at the end of the year.

How to prepare a Cash Flow Statement?

Here is a brief summary of our objectives. Although it appears simple, each line represents a number of previous calculations.

To achieve the above, we can either use the indirect or the direct method, whereby the indirect method is the more commonly used to calculate the three different cash flow activities.

Indirect Cash Flow method

Direct Cash Flow method

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Key takeaways

• A cash flow statement is one of the three financial statements businesses use to assess their financial health.
• The cash flow statement measures the cash that goes in and comes out of a company over a period of time.
• The indirect method is more commonly used to calculate the three different cash flow activities than the direct method.