Meaning Of Cash Flow Statement 

A cash flow statement (CFS) or statement of cash flow (SCF) reports the inflow and outflow of cash during a specified time period. It provides the reasons for the change in its cash and cash equivalents during a particular period. 

In simple terms, the cash flow statement explains the change in the company’s cash from the beginning of the year to the end of the year. 

Why Is The Cash Flow Statement Required?

There are two different methods of accounting, i.e., accrual and cash. Most companies use the accrual accounting method, which creates differences between the income statement and the company’s cash position. 

In such cases, a cash flow statement is an important statement that helps companies, analysts, and investors to evaluate the cash positions and financial health of a company. 

Like the statement of profit and loss account and balance sheet, the cash flow statement is an essential part of financial analysis. It helps:

·         Provides a detailed picture about cash received and payments made in a company during a specified period. 

·         It helps to understand if a business can pay its bills and generate enough cash to continue operations.

·         To check on liquidity and solvency, i.e., how much liquid cash your business has to operate your business operations. 

·         The cash flow from investing and financing activities reflects the cash position in assets and liabilities that helps to measure the performance.

·         It gives insight to the investors to understand the status of the company’s operations, including the sources of money and how efficiently the money is utilized. 

Cash Flow Format

A sample format of cash flow statement

Cash flow statement

Year ended March 22, 2022

Cash Flow Analysis

Now, let’s understand each aspect of the cash flow statement:

A cash flow statement is broken down into three activities, i.e., cash flow from operating activities, investing activities, and financing activities.

Cash Flow From Operating Activities:

The cash flow statement begins with operating activities which includes all operational business activities. It has cash flow from its core operations, i.e., buying or selling of inventory. A positive cash flow statement indicates a sign of a healthy company.

Examples:

·         Recurring expenses payments such as salaries, supplies, and rent.

·         Cash purchase or sale of inventory 

·         Additional operating expenses 

Cash Flow From Investing Activities:

This is the second section of the cash flow statement that includes cash flow related to the purchase and sale of long term investments such as property, equipment, plant and machinery, etc. Here, we find changes in capital expenditures.

For example, when capital expenditure is made, that means there is a cash outflow.

It should be noted here that it covers only those investing activities which are taken from free cash, i.e. investments made through debt are not included here. 

Examples:

·         Cash payment to purchase of securities

·         Cash payments from the acquisition of assets

·         Cash receipts from the sale of property, furniture, goodwill

·         Cash sale of investments 

Cash Flow From Financing Activities:

The last section of the cash flow statement covers cash flow from financing activities. It includes the cash flows associated with the financing activities, including debt and equity. 

It helps to analyze how much money the company has paid out via dividends, share buybacks, or cash obtained through equity.

Examples: 

·         Cash repayments of borrowings 

·         Dividend payments to shareholders

·         Redemption of preference shares, bonds, or debentures

·         Cash proceeds from the issue of shares, debentures, loans and other borrowings 

How Is Cash Flow Statement Prepared?

There are 2 methods to prepare cash flow statements under the cash flow from operating activities, i.e. direct or indirect methods. However, the calculation of the Cash Flow from Investing and Financing is similar.

Although both the methods result in the same number, but the process and adjustments are different. However, as per U.S. GAAP, it requires preparing a cash flow statement as per the indirect method. 

Cash Flow Statement Methods

1. Direct Method

The direct method of cash flow statement involves a straightforward process that involves gross cash receipts and cash payments only during a particular period.

Cash Flow Statement – Direct Method Format

2. Indirect method

The indirect method of cash flow statement involves cash received, cash payments and non-cash adjustments such as depreciation and amortizations.

Cash Flow Statement – Indirect Method Format

Now, to calculate cash flow from operating activities, there are mainly two steps:

1. Calculation of the operating profit

2. Consider the effect of change in working capital

*For example, if accounts receivable increase during a period, it means sales have increased, but due to credit sales, no cash was received at the time of sale. The cash flow statement deducts receivables from net income as no cash is involved yet. 

**Similarly, if the accounts payable decrease, that means a company has made payment to the suppliers; hence there is an outflow of cash.

How To Interpret A Cash Flow Statement?

Cash flow statements help to understand the phase of a business, i.e., whether it is in a rapidly growing startup, a matured company, or in a decline phase. 

If you see that a company has negative cash flow, then there could be the reason that the company is in the growth phase and spending cash to expand; in such case, if investors and lenders see a good opportunity, then it is not bad to invest in that business. 

However, they should keep track that operational cash flow must turn positive to continue the business as a going concern. 

On the other hand, if the company has negative cash flow in the long term, it indicates chances of bankruptcy. 

So, we can say, while preparing the cash flow statement, there are typically two results, i.e., positive cash balance or negative cash balance. 

Positive Cash Flow

It indicates that a company has more money flowing into the business than out of it over a specified period.

A positive cash flow is actually a good indication as we can interpret it as having excess cash that allows the company to invest in growth plans, pay off the debts, or distribute to the shareholders. 

Negative Cash Flow

Negative cash flow means your cash outflow is higher than your cash inflow during a period. It may be negative as the company has decided to expand its business and invest in future growth. 

To analyze the cash flow of any business, you may consider these significant aspects:

·         Analyze Positive Cash Flow

Having positive cash flow is an indicator of a company’s sustainability in the long run. 

·         Analyze negative cash flow

It depends upon the phase of a company, as negative cash flow is not always a bad sign. Sometimes, it could be investments to generate more returns, like investing in new plants and machinery to manufacture more products. 

·         Calculate free cash flow

The cash left after paying operating expenses and CAPEX is free cash flow. The company can use it to repay debts, make acquisitions, etc. Usually, a company having free cash twice or thrice their debts is in a healthy position.

·         Operating cash flow margin

A positive operating cash flow margin ratio indicates profitability and efficiency. You can calculate it by measuring cash from operating activities as a percentage of sales revenue.