Understanding (and Reading) a Cash Flow Statement

A cash flow statement is an important tool management should review consistently to gain valuable insights into the company’s financial health and identify emerging or potential problems.

What is a Cash Flow Statement?

Cash flow statements help you understand your company’s performance by stating how much cash it has on hand, how much it’s taking in, and how much it’s spending.

In a moment, we’ll delve into how you can read a cash flow statement. First, it’s important to understand the differences among various financial reports to appreciate the information a cash flow statement provides…

Cash Flow Statement vs. Income Statement

Unlike an income statement (also known as a profit and loss statement) that records revenue as it’s earned, a cash flow statement represents how much cash your company has available to run the business at a given point in time and provides historical information on your sources and uses of cash.

Cash flow and income statements can view the same transaction in different ways, so it’s essential to understand their distinct purposes. For instance, a non-cash item like depreciation is recorded on the income statement as an expense throughout the asset’s life. However, because depreciation does not represent an actual purchase that would reduce your available cash, it is added to the cash flow statement.

Cash Flow Statement vs. Cash Flow Forecast

While a cash flow statement looks at the present and recent past, a cash flow forecast uses a set of management assumptions to provide a forward-looking diagnostic model of what is expected to happen in the future.

Together, cash flow statements and forecasts help you understand your company’s financial situation by illustrating how much operating cash you have on hand (your liquidity), as well as your cash inflows and outflows.

This information, in turn, allows you to predict future cash flows and plan how much cash you’ll have available in future periods. This information is critical for making medium- and long-term plans and investment decisions for your company.

In addition, if you want to borrow money, your lender may need to review a cash flow statement or forecast to understand the company’s financial position and prospects.

How to Read a Cash Flow Statement

A cash flow statement is broken up into three parts: Cash Flow from Operating Activities, Cash Flow from Investing Activities, and Cash Flow from Financing Activities.

Operating Activities

This represents your net cash inflow or outflow resulting from your actual operations and indicates whether the business model is sustainable.

For example, Uber does not generate cash from operations. It uses cash and depends on additional financing to fund its operations. Cut off the financing, and Uber would struggle to maintain operations without significantly altering its business model. On the other hand, Amazon generates significant cash from operations and depends less on cash from investing or financing to operate.

Operating cash flow includes the following categories:

  • Net income (sales, changes in accounts receivable, and accounts payable)
  • Non-cash adjustments such as depreciation (which is an expense on the income statement but is added back to the cash flow statement to provide an accurate cash amount)
  • Changes in operating assets and liabilities

Investing Activities

This represents the purchase and sale of capital assets, such as equipment and other businesses. It also includes renovations, improvements, and other investments. These represent long-term investments in the company’s growth.

Financing Activities

Cash flows related to financing activities typically represent borrowings and repayments on term loans and lines of credit and the sale and repurchase of a company’s stock (including employee stock options), as well as dividends.

The Bottom Line (Literally)

Because ordinary business activities, such as a large inventory of capital equipment, can affect the results of a given period, a negative amount in one section of the report should be more of a cautionary note than a cause for concern. That said, negative operating cash flows, especially in more than one period, can indicate potential problems in your company’s financial health and a potential inability to raise needed cash from financings to continue to operate.

To learn more about the importance of cash flow in understanding your company’s financial health and managing potential risks, contact our Outsourced Accounting team for assistance in generating your cash flow reports.