A cash flow statement tells you the amount of cash and cash equivalents entering and leaving a business. It gives a detailed picture of how well a company has managed its cash during a specific period.
From reading a company's cash flow statement, you'll learn how it pays its debts with the money it has generated and how it funds its operating expenses.
Knowing how to read a cash flow statement will allow you to extract meaningful information about the health of a business.
A cash flow statement's information can be helpful whether you're a business owner, entrepreneur or investor, or working professional.
Cash flow statements tell business owners and entrepreneurs when they should modify their key strategies or initiatives. Investors can decide whether a company is a sound investment by understanding the information in a cash flow statement.
Cash flow statements help managers oversee budgets more effectively.
Although you don't need a degree in accounting to interpret a cash flow statement, understanding them can be challenging if you don't have a background in finance.
This article explains everything you need to know to read and understand a cash flow statement.
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Cash Flow Statement Components
A company's cash flow statement varies in depth and complexity based on business income and expenses.
However, all cash flow statements are made up of the following five components:
- Operating cash flow
- Net income
- Cash flow from investing activities
- Cash flow from financing activities
- Final cash amount
Let's take a closer look at these five components and how they contribute to a cash flow statement.
Operating Cash Flow
This is the first section of the cash flow statement and includes transactions from all operational business activities. These activities deal with a company's regular operating activities, including revenues and expenses.
Based on a company's operating cash flow, you can determine whether it has generated enough positive cash flow to maintain and grow its operations.
You can calculate operating cash flow using the following equation:
Operating Cash Flow = Net Income + Non-Cash Expenses – Increase in Working Capital
Because it explains how day-to-day operations impact the amount of cash a business has on hand, many consider it the most important component of the cash flow statement.
Based on the month's transactions with cash movement, the cash flow statement adjusts a company's net income.
Transactions reflected in cash from operations generally include accounts receivable, depreciation, accounts payable, changes in cash, and inventory.
Some examples are:
- Interest payments
- Wage or salary payments to employees
- Receipts from the sales of goods and services
- Income tax payments
- Other operating expenses
The goal of the operating cash flow is to evaluate the health of a company's everyday operations or core business. Thus financing and investment activities are excluded from the equation.
You can determine if a company has sufficient cash flow to pay its operating expenses, supply capital for future growth or investment activities, and meet its interest and debt requirements by reviewing the operating cash flow.
You're probably familiar with net income, even if you don't spend your days analyzing financial reports. You can calculate net income by subtracting a company's total sales from its expenses.
In other words, net income is a company's profits.
All cash flow statements begin with net income, which comes from a company's income statement or profit and loss report. Certain accounting methods, such as accrual accounting, include non-cash transactions when reporting net income.
When this happens, a company's net income won't reflect what they have in the bank. However, the cash flow statement makes necessary adjustments to net income to ensure a company's net cash reflects what's in its bank account.
Cash Flow from Investing Activities
In this section, you'll learn about the cash flow from a company's investments. Investment activities refer to the cash flow from selling or purchasing assets.
These assets may include real estate, vehicles, dividends from stocks owned in another company,
Cash Flow from Financing Activities
This refers to cash flow from debt and equity financing. It records the sources of cash such as bank loans, cash from your company's investors, and the dividends paid to shareholders.
Debt repayment, dividend payments, and payments for stock purchases all come under this category. Cash flow from financing activities is your net cash flows from activities.
Final cash amount
The last part of the cash flow statement is a combination of all of the preceding sections. This section is a company's actual cash value at the end of the period.
The final cash amount can be either a positive or negative value.
How to Read One
Now that you know the components of a cash flow statement, it's time to learn how to read one. Net income, operating cash flow, cash flow from investing, cash flow from investing, and final cash amount are the building blocks of a cash flow statement.
The sum of a company's operations, investing, and financing tells you the net change in cash flow for the period.
Carefully reading each section of a cash flow statement will reveal where a business is spending and receiving its cash. Understanding a company's cash flow statement gives you clues about its health.
A negative cash flow isn't always a concern if the business is healthy.
Example of a Cash Flow Statement
Below is an example of a cash flow statement:
If a business is acquiring new assets or making investments to keep the company moving forward, a negative cash flow is not a concern. A negative cash flow becomes concerning when a company loses money because its investments aren't successful.
Having a positive cash flow doesn't always mean a business is healthy. A company could have a positive cash flow because it has raised capital or borrowed capital it will have to repay in the future.
On the other hand, a positive cash flow could mean a company is making money hand over fist. Analyzing a cash flow statement will help you determine why a company has positive numbers.
Understanding how to read a cash flow statement will allow you to make informed decisions about a business, whether you're an investor, owner, or employee.
If you have any lingering questions, we've compiled this FAQs section to resolve any of your doubts.
A cash flow statement tells you how well a company manages its cash position. Based on this information, you can determine if a company is in a position to pay its debts and finance its operating expenses. Businesses must have cash on hand at all times to be successful.
Without cash, a business can't buy new assets, pay taxes, or repay loans. The cash flow statement is a report on a company's health.
The direct and indirect methods are the primary methods used to calculate cash flow. Using the direct method requires adding up all cash payments and receipts, including cash receipts from customers, wages paid to employees, and cash paid to suppliers.
The beginning and ending balances from business accounts and examining the net increase or decrease in these accounts is how the figure is calculated using the direct method.
The indirect method calculates cash flow from operating activities using the net income from a company's income statement. If a company uses accrual accounting, revenue doesn't count when it's received, only when it's earned.
Since net income isn't a true reflection of a company's net cash flow from its operating activities, a company's earnings before interest must be adjusted for items that impact net income. Adjustments are also made to add back non-operating activities that affect a business's operating cash flow.
A company might have a negative cash flow for several reasons, not all of them bad. The most obvious reason a company may have a negative cash flow is because the business is losing money.
In contrast, a company might have a negative cash flow due to the poor tine of income and expenses. A company can make a net profit while having a negative cash flow.
There are several ways a business can increase its cash flow, including the following:
- Consider leasing equipment and real estate instead of buying. That way, you only have to make payments in small amounts, which will help improve cash flow.
- Incentivize early payments for customers who pay before their bills are due. Getting cash early will improve your cash flow.
- Always conduct credit checks if a customer isn't paying in cash. This will allow you to take calculated risks and assess whether a customer will pay you on time.
You can reinvest your company's positive cash flow by following up on new leads to generate more sales for your business. You can use the profits you make from the sales generated with these leads to finance your business.
You can also reinvest by training your employees, conducting market research, hiring new staff, investing in new equipment, and buying or leasing new property.
You can gain a wealth of information about a business by reviewing its cash flow statement. At first glance, a cash flow statement may seem overwhelming if you don't have a background in finance.
However, reading and understanding a cash flow statement is not an impossible task.
Breaking a cash flow statement up into its five primary components makes it much easier to digest. Learning to read and understand a cash flow statement will unlock the doors to understanding a company's financial health.
I’m Donny. I’m a world traveler, investor, entrepreneur, and online marketing aficionado who has a big appetite to compete and disrupt big markets. I thrive on being able to create things that impact change, difficult challenges, and being able to add value in negative situations.