A cash flow statement is one of the three mandatory financial reports, including an income statement and balance sheet, which every organization is expected to file at regular intervals. It helps companies track cash inflows and outflows, and performance in terms of their ongoing operations, business activities, and external investments.

 

The cash flow statement also helps potential investors gauge if the company has a solid financial standing. It oversees how the organisation uses the money earned from its operations and manages debt obligations.

How Does Cash Flow Statement Work?

All companies that offer stocks to the general public are expected to file financial reports as well as statements with SEBI. The statement of cash flows focuses on cash accounting that records payment receipts and expenses as and when they are received and paid. 

 

A large number of companies make profits yet fail to manage their cash flows, which is where the cash flow statement makes a major difference. Through the cash flow statement, one can gain an insight into all sorts of transactions that a company indulges in. 

 

Analysing the cash flow statement aids in evaluating a company's ability to generate cash and meet its obligations. Positive cash flow indicates financial stability, while negative cash flow may suggest potential challenges.

Structure of Cash Flow Statement

The cash flow statement includes three main components based on business activity namely operating, investing, and financing. Here’s a detailed explanation of each of these activities: 

1. Cash Flows From Operations

This aspect of the cash flow statement covers all the cash inflows from business activities that are in operation at a given point in time. It gives an account of how much money is generated from the products and services provided by a company.

Some operational activities could fall under this category. They include:

  • Cash receipts from the sale of products and services of a company 

  • Payment of interests 

  • Payments made towards income tax

  • Payments made to the suppliers of goods and services in the production sector

  • Payment of salary and wages to employees

  • Payment of rent

  • Other operating expenses  

If it’s an investment company, it will include the receipts from the sale of loans, equities, or debt since they’re all business activities. 

2. Cash Flows From Investing

Cash flows from investing give you an idea of the gains made and losses incurred through investments. It includes money spent on long-term cash flow investments such as the purchase or sale of property, plant, and equipment. 

 

Activities such as the selling or purchasing of assets, loaning money to vendors, or loans received from customers fall under cash flows from investing. This also includes any merger or acquisition-associated payments. This category is also considered a cash outflow since it refers to the cash that is utilised to purchase new equipment, properties, or assets. 

 

Analysts often look at cash flows from investing to seek changes in capital expenditures. This is because when there is an increase in capital expenditures it implies that there is a cutback in cash flow. 

3. Cash Flows From Financing

This aspect of the cash flow statement gives a complete account of the cash utilised in business financing. Cash flows from financing comprise payments made for stock repurchases, dividends, and the repayment of loans undertaken by the company. 

 

Analysts use this information to find out how much cash an organisation has paid out through share buybacks or dividends. It also provides insight into how a company raises money to promote operational growth. 

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How Is Cash Flow Calculated?

How Is Cash Flow Calculated?

To calculate cash flow, the net income needs to undergo a few adjustments. This can be achieved by adding or subtracting differences in the revenue, credit transactions, and expenses. This needs to be done because non-cash transactions are generally looked after under the balance sheet and the income statement. 

 

There are two ways to calculate cash flow:

1. Direct Cash Flow Method

In this case, only the cash received and paid out as a result of a company’s operating activities are calculated. It uses all the gross receipts from operating activities such as cash received from customers, sales made, etc. 

 

Then, it subtracts them from gross payments, like cash paid to suppliers and salaries credited to employees, etc. However, this is except for non-cash items like depreciation and provision. This method is also referred to as the income statement method.

2. Indirect Cash Flow Method

Through the accrual accounting method, the expenses and revenue are calculated when the transaction is made rather than when they receive the money. Hence, net income from the income statement is considered under this method. 

 

The net income is then adjusted based on any changes in the assets and liabilities section on the balance sheet. Additionally, the company’s operating expenses are determined by adjustments made in non-operating expenses like accounts receivable, inventory, accounts payable, depreciation, etc. 

 

Although these expenses do not directly affect the flow of cash, they have to be included in the cash flow statement.

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Why is a Cash Flow Statement Important?

Every business requires adequate cash for the smooth functioning of its operations. Therefore, a cash flow statement plays a vital role in helping a company achieve success in the following ways:

1. Provides information about outflows

It helps analyse a company’s ability to make payments to its creditors. A cash flow statement also provides a detailed record of all the transactions. This includes credit to customers, purchasing inventory, capital equipment purchases, etc.

2. Maintains cash balance record

A cash flow statement provides a clearer picture of whether there is a lack of cash or if there are additional unused funds. Such an analysis will help the company utilise the excess cash on investments that add to its portfolio. However, if there is a lack of funds, the organisation can plan out strategies to borrow cash to help the business run without any issues.  

3. Focuses on cash generation

Every company aims to make profits through its business ventures. Profits are earned through the generation of cash which is why an organization must take well-planned decisions and maximise profit.

4. Helps in short-term planning

The statement of cash flows provides assistance in analysing transactions made in the past and their resulting consequences. This helps in creating a plan of action to make up for any deficit faced or tackle any surplus acquired.

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Limitations of Cash Flow Statement

A cash flow statement might sometimes show a negative cash flow that might raise a concern among investors. However, this need not necessarily mean that the company is on the brink of bankruptcy. 

 

An organisation might at times decide to expand its reach for future gains, and as a result, display poor cash flow in the present. Therefore, it is essential to analyse the changes in cash flow from one accounting period to another to get a better understanding of a company’s performance.

 

Additionally, the cash flow statement when examined alongside the income statement and the balance sheet helps get a finer grasp on how to plan for future financial goals.

FAQs

The cash flow statement provides information regarding the flow of cash in and out of the business. This helps investors get an idea of the company’s transactions and profitability.

The cash flow statement is divided into three main categories. These are cash flows from operations, investing, and financing. 

The formula for calculating cash flow is as follows:

Free Cash Flow = Operating Cash Flow - Capital Expenditure

The profit earned by a company during a particular period is called net income. Meanwhile, cash flow is the money that moves in and out of a company due to its business activities.

The cash flow statement helps a business keep track of all the cash inflows and outflows during a said accounting period. Whereas, an income statement helps keep a record of all transactions related to expenses, revenues, losses, and gains during a given accounting period.

A cash flow statement gives an account of all the money that flows in and out of a company as a result of its business activities. On the other hand, a balance sheet contains information regarding the organisation’s assets and liabilities. This also includes the amount invested by shareholders registered under the shareholders’ equity.

Cash flow is affected by several factors, including credit terms, inventory, accounts receivable, credit policy, and accounts payable.

When a company shows more outgoing funds than incoming funds, it is said to have a negative cash flow. This can be tackled through external investments and financing.

Here are a few ways cash flows can be improved: 

  • Negotiating for faster payment terms

  • Providing incentives and penalties to customers 

  • Checking the terms of accounts payable 

  • Cut down on unnecessary expenses 

  • Opting for leasing instead of buying 

  • Studying cash flow patterns 

  • Maintaining a forecast of cash flows

To create a cash flow statement you would need to follow three simple steps. They are given below: 

  • Ascertain a starting balance

  • Calculate cash flow from operating, investing, and financing activities

  • Determine the final balance

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