Kamal Okunola Written by MKO · 1 min read >

The cash flow statement. It’s one of the three main financial statements, but often overlooked.

The income statement provides information on revenue and profits over a certain period of time, and the balance sheet gives a snapshot of the financial health at a certain point in time.

But it’s in the cash flow statement where you can find out how effective a business is in managing its cash, and what it spends it on. Cash is the lifeblood of any business. A business that can’t pay its employees, vendors or your taxes anymore, is highly risky.

It’s important to understand that profits and cash can be two different things. Profit is defined as revenue minus expenses and in accrual accounting we report revenuewhen it’s earned, and expenses, when they’re incurred.

But earning revenue doesn’t always increase cash immediately. And incurring expenses doesn’t always decrease cash right away. Remember this important difference to cash accounting. If you want to find out how much cash a business has, you could just look in the balance sheet, there you’re going to be able to see if the cash position has gone up or down. But this way you won’t see how the cash came into the business and maybe even more importantly, what it was spent on. Therefore, to get a complete picture of the business, we also need to look at its cash flow statement. Just think of this as a report that shows you how cash was entering or leaving the business. If you see a positive figure, it means cash came into the company, and negative figure means cash left the business. A cash flow statement consists of three main parts:

The first one is the cash flow from operations. This is the most important part, because it shows you how much cash is generated with the actual operations of the business, meaning by selling the company’s products and services.

Then, we have the cash flow from investing activities, this is either cash spent on investments or cash received from sales of investments. In other words, it’s outside of the primary business activities of selling products and services. In this section we can see if the company purchased assets like machinery and equipment, or maybe even acquired another business.

Last one is the cash flow from financing activities. This section summarizes cash transactions that involved raising, borrowing and repaying capital. For instance, here we can see if the company issued new shares, if dividends were paid, if a bank loan was taken out, or if a debt principal was repaid.

At the very bottom of the statement you see the reconciliation to the balance sheet. It shows you the starting point of cash from the last period and the ending balance from the current balance sheet. The difference between the two is the net change of cash which has to equal the sum of the three cash flow sections above. In other words, beginning balance of cash, plus the cash flows from operations, investing and financing must equal the ending balance from the current balance sheet.


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