Have you ever looked at a profitable company and wondered why it’s still running out of cash? Well, the cash flow statement has the answer to that.
It is one of the three primary financial statements and is often underrated by non-finance individuals. Most people know about the income statement and balance sheet, but real ones know and understand the power behind the cash flow statement.
What Is The Cash Flow Statement?
The cash flow statement, or statement of cash flows, provides a detailed summary of a company’s cash movements (inflows and outflows) over a period. It usually covers a quarter or a financial year and provides an overview of how cash was generated and used during that time.
Unlike the income statement, the cash flow statement tells you what’s happening with a company’s cash.
Why It’s Essential
The statement of cash flows provides insight into how a business generates the cash it needs to meet its obligations, fund growth and sustain operations.
Other reasons of importance include the following.
Links the Income Statement and Balance Sheet
The cash flow statement starts with a profit figure from the income statement and ends with the cash balance on the balance sheet.
That profit figure is adjusted for non-cash items (like depreciation) and working capital changes. Cash flows from investing and financing activities are then accounted for to arrive at the company’s net change in cash over the period, reconciling the cash balance at the beginning and end of the period.
This reconciliation ensures consistency across the financial statements and gives stakeholders a complete view of a company’s operations.
Reveals A Company’s Cash Generating Ability
The statement of cash flows details how much operating cash flow a company generates (i.e., the cash generated from its core business).
Adjusting the profit figure for non-cash items and working capital changes reveals whether a company can cover day-to-day operations without external financing (debt).
Positive operating cash flow means healthy cash generation. The company generated sufficient funds to cover its daily operational costs. Negative operating cash flow equals poor cash generation. The company spent more than it generated and may need external funding to plug the hole.
Highlights Financial Risk
For the savvy investor, the cash flow statement can reveal potential red flags before they appear on any other financial statement and manifest in real life.
For example, an increasing trend of borrowing appears on the cash flow (in the financing activities section) before it negatively impacts a company’s profits (increased interest costs) and financial position (overleverage). This over-reliance on external financing is especially risky if used to cover operating expenses and other obligations.
A company can only borrow so much.
Structure of The Cash Flow Statement
The cash flow statement is divided into three sections, each outlining how cash moves through a business over a specific period.
Here’s a breakdown.
Cash From Operating Activities
This section focuses on how (and how much) cash is generated from a company’s core operations. It shows the cash inflows and outflows directly related to a company’s primary business activities.
Cash from operating activities can be calculated using the direct or indirect method.
- Direct Method: Lists and totals all the cash inflows and outflows related to a company’s operating activities.
- Indirect Method: Adjusts a company’s profit figure for non-cash items and working capital changes.
Most, if not all, companies use the indirect method.
Cash From Investing Activities
This section shows the cash inflows and outflows from investment-related activities. It gives investors insight into how a company uses cash to maintain its existing assets, expand operations through acquisitions, or generate returns from financial investments.
Examples of investing cash inflows:
- Proceeds from the sale of assets
- Proceeds from the sale of financial securities
Examples of investing cash outflows:
- Purchases of property, plant and equipment
- Acquisitions (of businesses)
Cash From Financing Activities
This section shows how the company funds its operations and growth through external financing (debt and equity). It tells if a business borrows to stay afloat or returns value to its shareholders.
Examples of financing cash inflows:
- Proceeds from issuing shares (equity financing)
- Proceeds from borrowing (debt financing)
Examples of financing cash outflows:
- Dividend payments
- Debt repayments
- Share buybacks
Net Change In Cash And Cash Equivalents
The net change in cash and cash equivalents summarises the total effects of a company’s cash flow over a period. It adds the net cash flows from operating, investing and financing activities.
Net Change in Cash and Cash Equivalents = Net Cash from Operating Activities + Net Cash From Investing Activities + Net Cash From Financing Activities
This total is then added to the company’s opening cash balance to determine its ending cash balance.
What The Cash Flow Statement Reveals
The cash flow statement isn’t just a list of inflows and outflows. When you know how to interpret it, you can uncover the financial truth about a company: its health, priorities and risks.
Is The Core Business Self-Sustaining?
Cash from operating activities is the heart of every business. It shows if a company is generating enough funds to keep itself running.
Interpretation:
- Consistently Positive Cash Flows: The company’s operations are sustainable, and its business model works.
- Growing Cash Flows: The company is likely scaling effectively.
- Negative Cash Flows: Red flag. Either operations are unprofitable, or working capital is mismanaged.
Where Is The Company Putting Its Money?
Cash from investing activities shows how much a company allocates to its future growth and where.
Interpretation:
- Negative Cash Flows: The company invested heavily in assets and growth initiatives. This is one of the few times a negative figure is a good thing.
- Positive Cash Flows: Arise from selling assets. It might indicate restructuring or downsizing.
How Is The Company Funding Its Strategy?
Cash from financing activities explains how a company manages its capital structure.
Interpretation:
- Positive Cash Flows: The company is raising capital (borrowing money or issuing shares)
- Negative Cash Flows: The company is repaying debt, paying dividends or repurchasing shares.
Is Cash Building Or Burning?
The bottom of the cash flow statement shows how all company activities (operating, investing, and financing) net out.
Interpretation:
- Positive Net Change in Cash: The company increased its cash reserves.
- Negative Net Change In Cash: More cash was spent than was generated.
Rounding It All Up!
The cash flow statement is often underestimated, but it’s one of the most revealing financial statements available. It answers key questions that other statements can’t:
- Is this company generating real cash or just profits?
- Can it fund growth internally, or is it relying on debt?
- Is it managing its resources wisely or burning through cash?
When used together, the cash flow statement, balance sheet and income statement complete a company’s financial picture. They provide a gateway to assess stability, profitability, strategic direction and risk exposure.
Whether you’re an investor, entrepreneur, student, or finance enthusiast, mastering the cash flow statement empowers you to see beyond the headlines and understand what’s happening inside a business.
