What Is Cash Flow Statement? Types, Examples, Features

March 25, 2023 Financial Modeling, Knowledge

A cash flow statement, also known as a statement of cash flows in financial accounting, is a financial statement that shows how changes in balance sheet accounts and income affect cash and cash equivalents. It also divides the statement analysis into operating, investing, and financing activities. It is primarily concerned with the flow of cash into and out of the business. It is also used as an analytical tool, is useful in determining a company’s short-term viability, particularly its ability to pay bills. The International Accounting Standard that deals with cash flow statement are International Accounting Standard 7.

Cash Flow Statement

The cash flow statement is a financial statement that shows the inflows and outflows of cash for a specific period. It is one of the three primary financial statements used by companies to report their financial performance, along with the balance sheet and the income statement. It’s history can be traced back to the early 20th century, with the development of accounting practices and the need for more comprehensive financial reporting.

History

The cash flow statement was first introduced in the United States in 1971 by the Financial Accounting Standards Board (FASB). This private, non-profit organization sets accounting standards in the U.S. The FASB created it to provide investors and other stakeholders with a more accurate view of a company’s cash flows, which was not available from the income statement or balance sheet alone.

Before its introduction, investors and analysts had to rely on the income statement and balance sheet to estimate a company’s cash flows. However, this approach was not always accurate, as the income statement recorded revenue and expenses when they were earned or incurred, regardless of when the cash was received or paid. Likewise, the balance sheet provided information on a company’s assets and liabilities but did not provide a comprehensive view of the cash inflows and outflows during a period.

It addressed these limitations by showing the actual cash inflows and outflows for a period, categorized into three sections: operating activities, investing activities, and financing activities. This allowed investors and analysts to gain a more accurate understanding of a company’s cash position, and to assess its ability to generate cash from its operations.

Over time, it became a standard financial statement required by accounting standards in the U.S. and other countries. Today, the cash flow statement is an essential part of financial reporting, providing valuable information about a company’s financial health and its ability to generate cash. It is used by investors, analysts, lenders, and other stakeholders to assess a company’s financial performance and make informed decisions about investment or lending.

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Definition and Activities 

It is a financial statement that shows the inflows and outflows of cash and cash equivalents during a specific period. The statement is used to help investors, creditors, and other stakeholders understand a company’s financial health and its ability to generate cash to meet its financial obligations.

The main three sections can be spit are Investing Activities, Operating Activities, and Financial Activities. 

Operating Activities:

This section provides the cash inflows and outflows reports that arise from a company’s normal business operations. It includes cash received from customers, cash paid to suppliers and employees, interest received and paid, and taxes paid. It also adjusts for non-cash transactions, such as depreciation and amortization, and changes in current assets and liabilities.

Investing Activities:

This section provides the cash inflows and outflows reports that arise from a company’s investment activities. It includes cash spent on acquiring or disposing of property, plant, and equipment, cash spent on acquiring or disposing of long-term investments, and cash received from the sale of investments. It also includes cash received from the sale of property, plant, and equipment.

Financing Activities:

This section provides the cash inflows and outflows reports that arise from a company’s financing activities. It includes cash received from issuing stocks or bonds, cash paid for the repurchase of stocks or bonds, and cash paid as dividends to shareholders. It also includes changes in short-term and long-term borrowing, such as loans and lines of credit.

Benefits 

It is an essential financial statement that shows the inflows and outflows of cash and cash equivalents during a specific period. Its purpose is to provide valuable information to investors, creditors, and other stakeholders about a company’s financial health and its ability to generate cash to meet its financial obligations. Here are some of the main purposes of a cash flow statement:

Helps Evaluate Liquidity:

It helps stakeholders assess a company’s liquidity, which is its ability to meet its short-term financial obligations. By showing the sources and uses of cash, the cash flow statement provides valuable information about a company’s ability to generate enough cash to cover its expenses and debts.

Helps Evaluate Profitability:

It is also used to evaluate a company’s profitability. Although it does not directly measure profitability, it shows the amount of cash generated or used in a period, which can be compared to a company’s net income on the income statement. If a company’s net income is higher than its cash flow from operations, it could indicate that the company is using accounting practices that overstate its profitability.

Provides Insights into Investing and Financing Activities:

It shows a company’s cash inflows and outflows related to investing and financing activities. By analyzing this information, stakeholders can gain insights into a company’s investment and financing strategies and assess its ability to generate cash from these activities.

Helps with Financial Planning:

It is a useful tool for financial planning. By understanding a company’s cash flows, stakeholders can identify potential cash shortages and take appropriate actions to address them. Additionally, the statement can help companies forecast future cash flows and plan for future investment and financing activities.

It also provides valuable information about a company’s cash flows and is an essential tool for assessing its financial health and ability to meet its financial obligations. It helps stakeholders evaluate a company’s liquidity and profitability, gain insights into its investing and financing activities, and plan for the future.

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Methods 

Direct Method:

The direct method is a method of preparing the cash flow statement where the actual cash inflows and outflows are reported for each major category of operating activities, including cash receipts from customers, cash paid to suppliers and employees, interest and taxes paid, and other operating activities. This method provides a more detailed view of the company’s cash flows and can be more useful for internal management purposes. However, it requires more effort to prepare, as it involves a detailed analysis of all cash transactions during the period.

Indirect Method:

The indirect method is a method of preparing it that starts with the net income reported on the income statement. It also adjusts changes in current assets and liabilities to arrive at the net cash flow from operating activities. This method is more commonly used, as it requires less effort to prepare and provides a clear reconciliation of the net income reported on the income statement to the net cash flow from operating activities. However, it provides less detail about the actual cash inflows and outflows than the direct method.

Both methods provide the same information in the end, but the presentation of the information is different. The investing and financing activities sections it are the same regardless of which method is used, and the ending cash balance will be the same in both methods.

In general, the indirect method is more widely used by companies because it is simpler to prepare and provides a clear reconciliation of net income to net cash flow from operating activities. However, the direct method can be useful for companies that want a more detailed view of their cash flows and for internal management purposes.

Benefits  

It is an important financial statement that provides information about the cash inflows and outflows of a company during a specific period. There are several benefits for investors, creditors, and other stakeholders, including:

Assessment of Liquidity:

It provides a detailed view of the cash inflows and outflows of a company. This information helps stakeholders assess the company’s liquidity and its ability to meet its short-term financial obligations. By comparing the cash inflows and outflows, stakeholders can determine whether a company has enough cash to pay its debts and operating expenses.

Evaluation of Financial Performance:

It can also help stakeholders evaluate a company’s financial performance. It shows the sources and uses of cash during a specific period, which can be compared to the company’s net income on the income statement. If the company’s net income is higher than its cash flow from operations, it may indicate that the company is using accounting practices that overstate its profitability.

Identification of Cash Shortages:

It can help companies identify potential cash shortages and take appropriate actions to address them. By analyzing the cash inflows and outflows, companies can identify areas where they can improve their cash management practices or where they need to secure additional financing.

Planning and Forecasting:

It can help companies plan and forecast their future cash flows. By analyzing their historical cash flows, companies can identify trends and make projections for future cash inflows and outflows. This information can be used to plan for future investments and financing activities.

Comparison with Industry Peers:

It provides a standardized measure of a company’s cash flows, which can be compared to industry peers. This allows stakeholders to evaluate a company’s financial performance and position relative to its competitors.

Among those who are interested are:

  • Accounting personnel who need to know whether the organization’s payroll and other immediate expenses will be covered.
  • Potential lenders or creditors seeking a clear picture of a company’s ability to repay Potential investors seeking to determine whether the company is financially sound.
  • Potential employees or contractors who want to know if the company can afford to pay them.
  • Company Directors are responsible for the governance of the company and ensuring that the company does not trade while its shareholders are insolvent.

It is an essential financial statement that provides valuable information about a company’s cash inflows and outflows. It helps stakeholders assess a company’s liquidity, evaluate its financial performance, identify potential cash shortages, plan and forecast future cash flows, and compare it with industry peers. These benefits make it a critical tool for investors, creditors, and other stakeholders.

Cash Flow Statement Vs Income Statement 

The cash flow statement and the income statement are two important financial statements that provide different information about a company’s financial performance. While both statements are critical in evaluating a company’s financial health, they serve different purposes and focus on different aspects of a company’s financial performance.

Purpose:

The income statement shows a company’s profitability by summarizing its revenues and expenses for a specific period, while the cash flow statement shows the inflows and outflows of cash during the same period. The income statement provides information about a company’s ability to generate profits, while the cash flow statement shows the actual cash available to a company.

Timing of Transactions:

The income statement records revenues and expenses based on when they are earned or incurred, regardless of when cash is received or paid. In contrast, the cash flow statement records cash transactions as they occur, regardless of when revenue or expenses are recognized. For example, a company may have recorded a sale on its income statement, but the cash may not have been received until a later period. The cash flow statement will show the actual cash inflows and outflows, while the income statement will show the revenue earned in that period.

Operating Activities:

The income statement records all revenues and expenses related to a company’s operating activities, while the cash flow statement records the actual cash inflows and outflows related to these activities. This means that the cash flow statement provides a more accurate view of a company’s ability to generate cash from its operations.

Non-Cash Items:

The income statement records non-cash items such as depreciation and amortization, which do not involve actual cash flows. The cash flow statement adjusts for these non-cash items to provide a more accurate view of the cash inflows and outflows during the period.

Investing and Financing Activities:

The cash flow statement also includes information on a company’s investing and financing activities, which are not included in the income statement. The investing section shows cash flows related to the purchase or sale of long-term assets, while the financing section shows cash flows related to the issuance or repayment of debt and equity.

While the income statement and cash flow statement are both important financial statements, they provide different information about a company’s financial performance. The income statement shows a company’s profitability, while the cash flow statement shows the actual cash inflows and outflows during a period. The two statements are complementary and should be used together to gain a complete picture of a company’s financial health.

Cash Flow Statement Vs Balance Sheet

They are two important financial statements that provide different information about a company’s financial position. While both statements are essential in evaluating a company’s financial health, they serve different purposes and focus on different aspects of a company’s financial performance.

Purpose:

The balance sheet provides a snapshot of a company’s financial position at a specific point in time, while the cash flow statement shows the inflows and outflows of cash during a particular period. The balance sheet provides information about a company’s assets, liabilities, and equity, while the cash flow statement shows the actual cash available to a company.

Timing of Transactions:

The balance sheet records a company’s assets, liabilities, and equity as of a specific point in time, while the cash flow statement records cash transactions as they occur during a specific period. The balance sheet provides a view of a company’s financial position at a specific point in time, while the cash flow statement shows the actual cash inflows and outflows during the period.

Liquidity:

The balance sheet provides information about a company’s liquidity, as it shows its current assets and current liabilities. Current assets are those that can be converted into cash within a year, while current liabilities are those that are due within a year. The cash flow statement provides additional information about a company’s liquidity, as it shows the actual cash inflows and outflows during the period.

Financing Activities:

The balance sheet includes information about a company’s long-term debt and equity, while the cash flow statement includes information about a company’s financing activities. The cash flow statement shows the inflows and outflows of cash related to the issuance or repayment of debt and equity.

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Operating Activities:

While the balance sheet does not directly provide information about a company’s operating activities, it indirectly shows the impact of these activities on a company’s financial position. For example, an increase in accounts receivable on the balance sheet can indicate that a company is generating more sales on credit. The cash flow statement shows the actual cash inflows and outflows related to a company’s operating activities.

The cash flow statement and the balance sheet are both important financial statements, they provide different information about a company’s financial position. The balance sheet shows a company’s assets, liabilities, and equity at a specific point in time, while the cash flow statement shows the actual cash inflows and outflows during a particular period. The two statements are complementary and should be used together to gain a complete picture of a company’s financial health.

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Frequently Asked Questions 

Q1. Why is a cash flow statement important?

It is important because it provides a more accurate view of a company’s cash flows than the income statement or balance sheet alone. It allows stakeholders to assess a company’s ability to generate cash, and to make informed decisions about investment or lending.

Q2. How is the cash flow statement different from the income statement?

It shows the actual cash inflows and outflows during a specific period, while the income statement shows revenue and expenses over the same period, regardless of when the cash was received or paid. The cash flow statement focuses on cash flows, while the income statement focuses on profit or loss.

Q3. How is the cash flow statement different from the balance sheet?

The balance sheet shows a company’s assets, liabilities, and equity at a specific point in time, while the cash flow statement shows the actual cash inflows and outflows during a particular period. The balance sheet provides a snapshot of a company’s financial position, while the cash flow statement shows the actual cash available to a company.

Q4. Who uses the cash flow statement?

It is used by a variety of stakeholders, including investors, analysts, lenders, and creditors. It is an essential part of financial reporting and allows stakeholders to assess a company’s financial performance and make informed decisions about investment or lending.

Conclusion

It ends with a net increase or decreases in cash and cash equivalents during the period. This amount is then needed to be added to the initial cash balance to get the total cash balance. It’s important to note that it only reflects the movement of cash, not the movement of non-cash items like inventory or accounts receivable. Therefore, it should be used in conjunction with the income statement and balance sheet to gain a complete picture of a company’s financial performance.

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