What Is a Cash Flow Statement (CFS)?

 A cash flow statement tracks the inflow and outflow of cash, providing insights into a company's
financial health and operational efficiency.

 A cash flow statement summarizes the amount of cash and cash equivalents entering and
leaving a company.

 The main components of the CFS are cash from three areas: Operating activities, investing
activities, and financing activities.

 The two methods of calculating cash flow are the direct method and the indirect method

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.

As one of the three main financial statements, the CFS complements the balance sheet and the income
statement.

How the Cash Flow Statement Is Used

The cash flow statement paints a picture as to how a company’s operations are running, where its
money comes from, and how money is being spent. Also known as the statement of cash flows, the CFS
helps its creditors determine how much cash is available (referred to as liquidity) for the company to
fund its operating expenses and pay down its debts.

The CFS is equally important to investors because it tells them whether a company is on solid financial
ground. As such, they can use the statement to make better, more informed decisions about their
investments.

Structure of the Cash Flow Statement

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).1

Cash From Operating Activities

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

In the case of a trading portfolio or an investment company, receipts from the sale of loans, debt,
or equity instruments are also included because it is a business activity.

Changes made in cash, accounts receivable, depreciation, inventory, and accounts payable are generally
reflected in cash from operations.

Cash From Investing Activities

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

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.
How to Prepare a Cash Flow Statement

1 . Gather Financial Statements

Before you begin, collect the necessary financial statements:

 Income statement: Provides information on revenues, expenses, and net income.

 Balance sheet: Shows the company’s assets, liabilities, and equity at the beginning and end of
the period.

2. Determine the Reporting Period

Identify the period for which you are preparing the cash flow statement. This could be monthly,
quarterly, or annually.

3. Choose the Method

Decide whether you will use the direct method or the indirect method to prepare the CFS.

 Direct Method: The direct method involves listing all cash receipts and payments during the
reporting period.

 Indirect Method: The indirect method starts with net income and adjusts for changes in non-
cash transactions.

4. Prepare the Statement

Cash Flow from Operating Activities

Direct Method:

1. List cash receipts: Include cash collected from customers.

2. List cash payments: Include cash paid to suppliers, employees, interest paid, and income taxes
paid.

3. Calculate net cash flow from operating activities: Subtract total cash payments from total cash
receipts.

Indirect Method:

1. Start with net income: Obtain this from the income statement.

2. Adjust for non-cash items: Add back depreciation and amortization.

3. Adjust for changes in working capital: Account for changes in accounts receivable, inventory,
accounts payable, and other working capital accounts.
 4. Calculate net cash flow from operating activities: Combine the adjusted net income with
changes in working capital.

Cash Flow from Investing Activities

1. Identify cash transactions for investments: Include cash spent on purchasing fixed assets, cash
received from selling assets, and cash spent on or received from investing in securities.

2. Calculate net cash flow from investing activities: Subtract cash payments for investments from
cash receipts from sales of investments.

Cash Flow from Financing Activities

1. Identify cash transactions for financing: Include cash received from issuing stock or debt and
cash spent on repaying debt or buying back stock.

2. Calculate net cash flow from financing activities: Subtract cash payments for financing activities
from cash receipts from financing activities.

5. Combine All Sections

Add the net cash flows from operating, investing, and financing activities to determine the overall
change in cash and cash equivalents for the period.

6. Reconcile with Beginning Cash

Add the change in cash to the beginning cash balance to arrive at the ending cash balance, ensuring it
matches the cash balance reported on the balance sheet.

How Cash Flow Is Calculated

There are two methods of calculating cash flow: the direct method and the indirect method.

Direct Cash Flow Method

The direct method adds up all of the cash payments and receipts, including cash paid to suppliers, cash
receipts from customers, and cash paid out in salaries. This method of CFS is easier for very small
businesses that use the cash basis accounting method.

These figures can also be calculated by using the beginning and ending balances of a variety of asset
and liability accounts and examining the net decrease or increase in the accounts. It is presented in a
straightforward manner.

Most companies use the accrual basis accounting method. In these cases, revenue is recognized when it
is earned rather than when it is received. This causes a disconnect between net income and actual cash
flow because not all transactions in net income on the income statement involve actual cash items.
Therefore, certain items must be reevaluated when calculating cash flow from operations.
Indirect Cash Flow Method

With the indirect method, cash flow is calculated by adjusting net income by adding or subtracting
differences resulting from non-cash transactions. Non-cash items show up in the changes to a
company’s assets and liabilities on the balance sheet from one period to the next. Therefore, the
accountant will identify any increases and decreases to asset and liability accounts that need to be
added back to or removed from the net income figure, in order to identify an accurate cash inflow or
outflow.
Creating a cash flow statement from your income statement and balance
sheet

Let’s say we’re creating a cash flow statement for Greg’s Popsicle Stand for July 2019.

Our income statement looks like this:

Note: For the sake of simplicity, this example omits income tax.

And our balance sheet looks like this:

Remember the four rules for converting information from an income statement to a cash
flow statement? Let’s use them to create our cash flow statement.
 Our net income for the month on the income statement is $3,500 — that stays the
same, since it’s a total amount, not a specific account.

Additions to Cash

 Depreciation is included in expenses for the month, but it didn’t actually impact cash, so
we add that back to cash.
 Accounts payable increased by $5,500. That’s a liability on the balance sheet, but the
cash wasn’t actually paid out for those expenses, so we add them back to cash as well.

Decreases to Cash
 Accounts receivable increased by $4,000. That’s an asset recorded on the balance
sheet, but we didn’t actually receive the cash, so we remove it from cash on hand.

Our net cash flow from operating activities adds up to $5,500.

Cash Flow from Investing Activities

Greg purchased $5,000 of equipment during this accounting period, so he spent $5,000
of cash on investing activities.

Cash Flow from Financing Activities

Greg didn’t invest any additional money in the business, take out a new loan, or make
cash payments towards any existing debt during this accounting period, so there are no
cash flows from financing activities.

Cash Flow for Month Ending July 31, 2019 is $500, once we crunch all the numbers.
Greg started the accounting period with $5,500 in cash. After accounting for all of the
additions and subtractions to cash, he has $6,000 at the end of the period.