The Motley Fool

What Is: The Cash Flow Statement

A company’s cash flow statement provides an overview of all cash-related activities for a given period of time. It includes operating activities such as changes in account payables and inventories, investing activities such as capital expenditures, and financing activities such as paying dividends or buying or selling stock.

„Follow the money,“ is a classic TV-detective line when they’re tracking down someone who might benefit from a crime. But it’s equally important to you when you want to keep track of a business’s performance.

The cash flow statement shows you, the investor or analyst, how cash is moving through a business. It reconciles the bottom-line profit and loss result, which is a non-cash number, with the actual cash coming into or leaving the business. It shows what the company is doing with its cash, where that cash is from, and how much of it stays within the business at the end of the reporting period.

On the cash-flow statement, any negative number is cash flowing out of the business (for instance, adding to inventory), while any positive number is cash flowing into the business (for instance, taking out a loan).

Given an income statement and a balance sheet, it is possible to construct the cash flow statement.

Important point: Interim cash flow statements — those reported between either end of the company’s fiscal year, such as in the second or third quarter — are cumulative from the end of the previous year. In order to determine the various cash flows for that quarter alone, you’ll need to subtract the figures from the previous quarter’s statement.

The cash flow statement is broken down into three sections, which are always presented in this order:

  • operating activities,
  • investing activities, and
  • finance activities.

Cash from operating activities
This is presented in two different ways. The indirect method, followed by most U.S. and international companies, begins with net income. The direct method, followed by some foreign companies, begins with revenue.

Indirect method

For this presentation, this section begins with net income and then adjusts for any and all non-cash income or expenses, ending with cash flow from operations. Adjustments include the following:

  • depreciation,
  • amortization,
  • stock-based compensation, and
  • working capital changes, which includes changes to:
    • accounts payable,
    • accounts receivable,
    • inventory,
    • “other,” including things like salary payable, prepaid expenses, etc.

Depending on the nature of the item or the direction of the change in the balance sheet accounts, these items are either added or subtracted to net income. After all of that, you are left with net cash from operating activities.

Direct method

Beginning with revenue, this method adds or subtracts all cash expenses (such as salary payments, inventory purchases, or cash receipts from accounts receivable). It ends up at net cash from operating activities. This will be the same amount found by using the indirect method. In fact, if a company reports using the direct method, it must also supply the indirect method as a supplementary report (FAS 95).

Cash from investing activities
This section shows all the cash the business spent on or received from investments. You will see things like capital expenditures, purchase (or sale) of marketable securities, and acquisitions of other businesses.

Cash from financing activities
This section details how the company is raising additional cash (such as from debt or issuing stock), sharing cash with investors (paying dividends or buying back stock), or using cash to pay back debt. Adding all that up we are left with net cash from financing activities.

Summing up
The net cash from all three sections are then added up to calculate the net change in cash which reflects the change in cash and equivalents on the balance sheet.