The cash flow statement is one of three key financial statement for a company. The others: income statement and balance sheet. The changes in cash flow for the period covered by the statement generally come from information found in the income statement and balance sheet.
What is a cash flow statement?
A cash flow statement is a financial statement that provides data regarding a company’s cash inflows and outflows from all sources, including operations, financing, and investments.
The cash flow statement draws upon data from the company’s other main financial statements: the income statement and the balance sheet. Cash flow is a key metric for a company. While earning a high level of income is the goal of a company, cash flow is the life blood of any business. This is the money that the business can actually spend on operations for items such as meeting payroll, purchasing goods and services used in the normal course of its business operations, and other spending done in the course of its day-to-day operations.
Investors and lenders considering doing business with the company focus on cash flows, especially to changes in cash flow from year-to-year.
How to prepare a statement of cash flow
In preparing the cash flow statement there are a few things that must be understood.
Cash versus accrual accounting
Most public companies use an accrual basis of accounting, versus the cash-based accounting that many small businesses and individuals use. Accrual accounting means that revenue is recognized when a sale occurs, not when the cash is received for this sale.
This is an example of how the income statement and the balance sheet factor into the cash flow statement for a business.
Once a sale is recorded as revenue when a transaction takes place, several things happen:
The sale is recorded as revenue on the company’s income statement. A portion of this revenue also flows down through the income statement to the “bottom line” net income. Note that no cash has been received by the company for this transaction so far.
The sale also triggers entries on the company’s balance sheet. Let’s say in this example that the company’s payment terms are 30 days from the date of the sale. On the balance sheet, the amount of the sale is added to the company’s accounts receivable. This is a short-term asset in that it is anticipated that it will be converted to cash within a year.
Once payment is made, there is no impact on the company’s income statement. On the balance sheet, the amount paid will serve to reduce accounts receivable and increase cash.
Sources of cash flow
Companies generally have three main sources of cash flow. These are operations, investments and financing.
Cash flow from operations
Cash flow from operations primarily includes revenues earned from the sale of the product(s) or service(s) the firm offers. For example, a company that sells pharmaceuticals and related products would realize revenue from the sale of their products or any related services. Cash from these sales would come in when the customer pays for them, either immediately or based on the terms of sales associated with the transaction.
Cash outflows would arise from the company’s expenses. These could include the payment of wages to employees, the purchase of raw materials used in the manufacturing of their products, the cost of transporting their products to their customers or elsewhere, the cost to rent facilities used in conducting business (if applicable), and the payment of taxes.
Cash flow from investments
Companies may make both external investments and internal investments in the form of capital expenditures.
External investments might include an investment in an outside company or project or the purchase of the company’s own shares in the open market known as a stock buyback.
Cash flows from these external investments can include the costs to initially make these investments, a cash outflow, or inflows from various types of return on these investments. The latter can include proceeds from selling the investment (at a gain or at a loss), periodic returns in the form of dividends, or interest.
Internal investments, such as capital expenditures relating to opening a new facility, the acquisition of another business or investments in heavy equipment all generally involve some sort of cash outlay to the extent they are financed internally.
Cash flow from financing
Sources of cash flows from financing activities include funds from financing obtained from banks and other lenders as well as from the issuance of debt securities like bonds. Increases in these items on the firm’s balance sheet represent sources of cash. Decreases would signify a use or decrease in the company’s cash flow for the period depicted in the statement.
A company raising capital in the form of shareholder’s equity from the sale additional shares of their stock to investors would constitute a source of cash flow for the period.
Transactions in the financing area that would serve to decrease cash flow include:
The payment of interest to bondholders or related to servicing a bank loan
The payment of dividends to shareholders
Sources and uses of cash
When preparing the statement of cash flows, the idea of sources and uses of cash is an important concept. Sources and uses of cash from the balance sheet include:
Sources:
Decreases in current assets such as accounts receivable and inventories. A decrease in accounts receivable would indicate that receivables have been collected and converted to cash. A decrease in inventory would equate to less cash tied up in this asset.
An increase in current liabilities such as accounts payable would indicate that the company may be waiting longer to pay vendors and conserving cash in that manner.
If the company issues equity or increases the amount of their debt, this would be a source of cash for the company.
Uses:
Increases in assets such as buildings or equipment will generally be a use of cash. Likewise, inventory items are ultimately paid for with cash. Increases in accounts receivable would indicate a larger amount of the company’s sales revenue that is waiting to be collected as cash.
Sources and uses of cash from the income statement include:
Net income (although it needs to be reconciled to convert it to an increase or decrease in cash flows for the period)
Revenues may come from cash sales.
Expenses for things like rent or taxes would also reduce a company’s cash flow.
Cash flow statement example/template
The cash flow statements for Amazon below offer a look at the sources and uses of cash for this major company over several years.
Cash flow statement for Amazon (ticker AMZN)
A few highlights:
Note that the starting point is net income for the period being shown.
Depreciation is a reconciling item as it is a non-cash expense. Depreciation pertains to a periodic write-down in the value of capital assets such as a piece of heavy equipment that may have been purchased in a prior period. Depreciation is an expense that decreases net income and can help reduce taxable income for the company. However, the cash impact of the assets purchased may not pertain to the current period.
This first section of the cash flow statement includes changes from assets and liabilities on the company’s balance sheet as discussed in prior sections of this article above.
The final section is cash flow from financing activities. The changes in the appropriate sections of the balance sheet represent sources or uses of cash for the company.
Personal vs. business cash flow statement
Personal and business cash flow statements are both sources of uses of cash. Granted these sources and uses may be vastly different, but a cash flow statement is about showing the changes in cash flow and areas that contributed to these changes. And in that way, they are the same.
Individuals are always on a cash basis meaning that their accounting always centers around the timing of the cash. Some businesses are as well. This is often the case with smaller companies.
Larger companies are generally on an accrual basis meaning that many transactions are recorded when they occur, not when the cash changes hands. The recording of revenue is prime example. Revenue is recorded when the sale is made, not when the cash is collected. This time difference between the sale transaction and the payment for the item or service sold is accounts receivable.
