Accounting And Finance Skills

The Cash Flow Statement




The cash flow statement is one of the three main financial statements (along with the income statement and balance sheet) and shows how cash moves in and out of your business over a specific period. It focuses on cash transactions only, providing critical insights into the business's liquidity and ability to meet short-term obligations.

This simple guide explains what a cash flow statement is, its components, and how to analyze it.

1. What Is a Cash Flow Statement?

A cash flow statement details the actual inflows and outflows of cash within a business, helping you understand how cash is being generated and spent.

Key Purposes:

  1. Liquidity Management: Determines if your business has enough cash to meet day-to-day expenses.
  2. Operational Health: Tracks cash generated from core business activities.
  3. Decision-Making: Helps plan for investments, loan repayments, or expansions.

2. Structure of a Cash Flow Statement

A cash flow statement is divided into three main sections:

A. Operating Activities (Cash from Operations):

Cash generated or spent from your core business activities, such as:
- Revenue from sales.
- Payments to suppliers and employees.
- Operating expenses (e.g., rent, utilities).

Example of Operating Cash Flows:

  • Cash received from customers.
  • Cash paid for raw materials, wages, and overhead expenses.

B. Investing Activities (Cash from Investments):

Cash spent on or earned from long-term investments, such as:
- Purchase or sale of property, equipment, or assets.
- Investments in securities or other companies.

Example of Investing Cash Flows:

  • Purchase of machinery (-).
  • Sale of unused office equipment (+).

C. Financing Activities (Cash from Financing):

Cash received from or paid to fund your business, including:
- Borrowing money (e.g., loans).
- Repaying loans.
- Issuing stock or paying dividends.

Example of Financing Cash Flows:

  • Loan proceeds received from a bank (+).
  • Dividend payments to shareholders (-).

D. Net Cash Flow:

The final total from all three sections:
Net Cash Flow = Operating Cash Flow + Investing Cash Flow + Financing Cash Flow

3. Example of a Cash Flow Statement

Here’s a sample cash flow statement for ABC Company for the year ending December 31, 2025:

| ABC Company Cash Flow Statement | For the Year Ended December 31, 2025 |
|-------------------------------------------|------------------------------------------|
| Cash Flow from Operating Activities: | |
| Net Income | $30,000 |
| Adjustments for Non-Cash Items: | |
| - Depreciation | $5,000 |
| - Changes in Working Capital: | |
| - Increase in Accounts Receivable | ($3,000) |
| - Increase in Accounts Payable | $2,000 |
| Net Cash from Operating Activities: | $34,000 |
| | |
| Cash Flow from Investing Activities: | |
| Purchase of Equipment | ($10,000) |
| Proceeds from Sale of Equipment | $2,000 |
| Net Cash from Investing Activities: | ($8,000) |
| | |
| Cash Flow from Financing Activities: | |
| Loan Proceeds | $20,000 |
| Dividend Payments | ($5,000) |
| Net Cash from Financing Activities: | $15,000 |
| | |
| Net Increase in Cash: | $41,000 |
| Opening Cash Balance (Jan 1, 2025): | $10,000 |
| Closing Cash Balance (Dec 31, 2025): | $51,000 |

4. Steps to Create a Cash Flow Statement?

Step 1: Start with Net Income

Begin with the net income from your income statement. This is the starting point for the operating activities section.

Step 2: Adjust for Non-Cash Items

Add back non-cash expenses (e.g., depreciation, amortization) that were deducted in the income statement but didn’t involve actual cash.

Step 3: Account for Changes in Working Capital

Adjust for changes in:
- Accounts Receivable: If receivables increased, cash flow decreases because you haven’t received the money yet.
- Accounts Payable: If payables increased, cash flow increases because you haven’t paid the money yet.
- Inventory: If inventory increased, cash flow decreases because cash was spent on goods.

Step 4: Record Investing Activities

Include cash transactions related to buying or selling long-term assets (e.g., equipment, property).

Step 5: Record Financing Activities

Include cash from loans, repayments, issuing shares, or paying dividends.

Step 6: Calculate Net Cash Flow

Add up all cash inflows and outflows from the three sections.

5. How to Analyze a Cash Flow Statement

A. Assess Cash from Operating Activities

  • Look at whether the business is generating positive cash flow from its core operations.
  • Red Flag: If operating cash flow is consistently negative, the business may rely too much on loans or investments to stay afloat.

B. Evaluate Investing Activities

  • If investing cash flow is negative, it could mean the business is investing in growth (e.g., buying equipment or property).
  • Red Flag: Selling too many assets to generate cash could indicate financial distress.

C. Review Financing Activities

  • Positive financing cash flow typically means the business is raising capital (e.g., through loans or equity).
  • Negative financing cash flow often reflects loan repayments or dividend payouts.
  • Red Flag: Heavy reliance on financing to cover operating losses may indicate unsustainable growth.

D. Analyze Cash Flow Trends

Compare cash flow statements across multiple periods to spot trends:
1. Is cash flow from operating activities improving or declining?
2. Are investments aligned with business growth?
3. Is the business over-reliant on financing?

6. Key Ratios Derived from the Cash Flow Statement

A. Operating Cash Flow Ratio:

Measures the company’s ability to cover current liabilities using cash from operations.

Formula:
Operating Cash Flow Ratio = Cash from Operations ÷ Current Liabilities

Example:

  • Cash from Operations = $34,000
  • Current Liabilities = $20,000
  • Operating Cash Flow Ratio = $34,000 ÷ $20,000 = 1.7

Interpretation:
- A ratio >1 means the company can cover its short-term liabilities using cash from operations.

B. Free Cash Flow (FCF):

Measures the cash available after covering operating and capital expenses.

Formula:
Free Cash Flow = Cash from Operations - Capital Expenditures (CAPEX)

Example:

  • Cash from Operations = $34,000
  • CAPEX = $10,000
  • Free Cash Flow = $34,000 - $10,000 = $24,000

Interpretation:
- Positive FCF indicates the business has cash available for growth, dividends, or debt repayment.

C. Cash Flow Margin:

Shows how much cash flow is generated relative to revenue.

Formula:
Cash Flow Margin = (Cash from Operations ÷ Revenue) × 100

Example:

  • Cash from Operations = $34,000
  • Revenue = $100,000
  • Cash Flow Margin = ($34,000 ÷ $100,000) × 100 = 34%

Interpretation:
- A higher margin indicates better cash generation efficiency.

7. Red Flags in a Cash Flow Statement

  1. Consistently Negative Cash Flow from Operations:

  2. Indicates the business isn’t generating enough cash to sustain itself.

  3. High Reliance on Financing:

  4. If most cash inflow comes from loans or equity, it could indicate financial instability.

  5. Declining Free Cash Flow:

  6. Suggests less cash is available for reinvestment or paying down debt.

8. Tools for Preparing and Analyzing Cash Flow Statements?

  1. Accounting Software:

  2. QuickBooks, Xero, and Wave can generate cash flow statements automatically.

  3. Spreadsheets:

  4. Create custom cash flow statements and analyze trends using Excel or Google Sheets.

  5. Consult an Accountant:

  6. Professionals can help you create and interpret cash flow statements, especially for complex businesses.

Things to Remember

  1. The cash flow statement tracks cash inflows and outflows, focusing on operating, investing, and financing activities.
  2. Positive cash flow from operations is critical for long-term sustainability.
  3. Use ratios like free cash flow and the operating cash flow ratio to evaluate financial health.
  4. Analyzing cash flow trends over time helps identify areas for improvement and ensure liquidity.
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