Cash Flow Statement

The Three Major Financial Statements: How They’re Interconnected:

The cash flow statement provides a view of a company’s overall liquidity by showing cash transaction activities. It reports all cash inflows and outflows over the course of an accounting period with a summation of the total cash available.

The CFS measures how well a company manages its cash position, meaning how well the company generates cash to pay its debt obligations and fund its operating expenses.

The cash flow statement measures the performance of a company over a period of time. But it is not as easily manipulated by the timing of non-cash transactions. As noted above, the CFS can be derived from the income statement and the balance sheet. Net earnings from the income statement are the figure from which the information on the CFS is deduced. But they only factor into determining the operating activities section of the CFS. As such, net earnings have nothing to do with the investing or financial activities sections of the CFS.

The income statement includes depreciation expense, which doesn’t actually have an associated cash outflow. It is simply an allocation of the cost of an asset over its useful life. A company has some leeway to choose its depreciation method, which modifies the depreciation expense reported on the income statement. The CFS, on the other hand, is a measure of true inflows and outflows that cannot be as easily manipulated.

As for the balance sheet, the net cash flow reported on the CFS should equal the net change in the various line items reported on the balance sheet. This excludes cash and cash equivalents and non-cash accounts, such as accumulated depreciation and accumulated amortization. For example, if you calculate cash flow for 2019, make sure you use 2018 and 2019 balance sheets.

The main components of the cash flow statement are:

1. Cash flow from operating activities
2. Cash flow from investing activities
3. Cash flow from financing activities
4. Disclosure of non-cash activities, which is sometimes included when prepared under  generally accepted accounting principles (GAAP)

The  operating activities on the CFS include any sources and uses of cash from business activities. In other words, it reflects how much cash is generated from a company’s products or services.

These operating activities might include:

• Receipts from sales of goods and services
• Interest payments
• Income tax payments
• Payments made to suppliers of goods and services used in production
• Salary and wage payments to employees
• Rent payments
• Any other type of operating expenses

Investing activities include any sources and uses of cash from a company’s investments. Purchases or sales of assets, loans made to vendors or received from customers, or any payments related to  mergers and acquisitions (M&A) are included in this category. In short, changes in equipment, assets, or investments relate to cash from investing.

Changes in cash from investing are usually considered cash-out items because cash is used to buy new equipment, buildings, or short-term assets such as marketable securities. But when a company divests an asset, the transaction is considered cash-in for calculating cash from investing.

Cash from financing activities includes the sources of cash from investors and banks, as well as the way cash is paid to shareholders. This includes any dividends, payments for  stock repurchases, and repayment of debt principal (loans) that are made by the company.

Changes in cash from financing are cash-in when capital is raised and cash-out when dividends are paid. Thus, if a company issues a bond to the public, the company receives cash financing. However, when interest is paid to  bondholders, the company is reducing its cash. And remember, although interest is a cash-out expense, it is reported as an operating activity—not a financing activity.