The statement of cash flows is a financial statement that reports the change (either an increase or a decrease) in a company’s cash balance over a period of time. The statement can be the most intuitive of all the financial statements because it reports cash inflows and outflows from operating, investing and financing activities over a period of time. A cash flow statement provides aggregate data regarding all cash inflows a company receives from its ongoing operations and external investment sources.
A company’s financial statements offer investors and analysts a portrait of all the transactions that go through the business, where every transaction contributes to its success. In cash flow statement, the three different sections of the cash flow statement can help investors determine the value of a company’s stock or the company as a whole.
How Cash Flow Statements Work
Generally, a company’s net cash flow for a period does not equal its net income for the period. This is due to timing differences between when revenue and expense items are recognized on the income statement and when cash is received and paid. (We discuss this concept further in subsequent modules.)
Both cash flow and net income numbers are important for business decisions. Each is used in security valuation models, and both help users of accounting reports understand and assess a company’s past, present, and future business activities
Three Sections of the Statement of Cash Flows:
- Operating Activities: The principal revenue-generating activities of an organization and other activities that are not investing or financing; any cash flows from current assets and current liabilities.
- Investing Activities: Any cash flows from the acquisition and disposal of long-term assets and other investments not included in cash equivalents
- Financing Activities: Any cash flows that result in changes in the size and composition of the contributed equity capital or borrowings of the entity (i.e., bonds, stock, dividends)
The reason for the difference between cash and profit is because the income statement is prepared under the accrual basis of accounting, where it matches revenues and expenses for the accounting period, even though revenues may actually not have yet been collected and expenses may not have yet been paid. In contrast, the cash flow statement only recognizes cash that has actually been received or disbursed.
How to Use the Statement of Cash Flows
The statement of cash flows can be used to discern trends in business performance that are not readily apparent in the rest of the financial statements. It is especially useful when there is a divergence between the amount of profits reported and the amount of net cash flow generated by operations. Many investors feel that the statement of cash flows is the most transparent of the financial statements (i.e., most difficult to fudge), and so they tend to rely upon it more than the other financial statements to discern the true performance of a business. They can use it to determine the sources and uses of cash.
There can be significant differences between the results shown in the income statement and the cash flows in this statement, for the following reasons:
- There are timing differences between the recordation of a transaction and when the related cash is actually expended or received.
- Management may be using aggressive revenue recognition to report revenue for which cash receipts are still some time in the future.
- The business may be asset intensive, and so requires large capital investments that do not appear in the income statement, except on a delayed basis as depreciation.