CASHFLOW STATEMENT
The Statement of Cash Flows (SCF) is a financial statement that summarizes the movement of
cash and cash equivalents both into and out of a company during a specific period. It essentially
shows how a company generates and uses cash. Unlike the Income Statement and Balance
Sheet, which use accrual accounting, the SCF focuses solely on actual cash transactions.
I. Purpose of the Statement of Cash Flows:
• Assess Liquidity: Provides insights into a company's ability to meet its short-term obligations.
• Evaluate Solvency: Helps assess a company's ability to meet its long-term obligations.
• Analyze Investing and Financing Activities: Shows how a company is investing in its future and
how it's funding those investments.
• Predict Future Cash Flows: Historical cash flow patterns can be used to forecast future cash
flow performance.
• Compare Performance: Allows for comparison of cash flow performance between different
companies.
• Reconcile Net Income to Cash Flow: Explains the differences between net income (accrual-
based) and cash generated from operations.
II. Structure of the Statement of Cash Flows:
The SCF is divided into three main sections:
1. Cash Flows from Operating Activities (CFO): This section reports the cash effects of
transactions that create revenues and expenses - in other words, the company's core business
activities. It typically starts with net income and then adjusts for non-cash items and changes in
working capital accounts.
• Two Methods for Calculating CFO:
* Direct Method: Reports the actual cash inflows and outflows from operating activities (e.g.,
cash received from customers, cash paid to suppliers). While theoretically more accurate, it's
less commonly used because it requires more detailed tracking of cash transactions.
* Indirect Method: Starts with net income and adjusts it to reconcile it to cash flow from
operations. This is the more commonly used method. Adjustments include:
* Adding back non-cash expenses: Depreciation, amortization, depletion, stock-based
compensation. These expenses reduced net income but didn't involve an actual cash outflow.
* Adjusting for changes in current assets and current liabilities:
Increase in current assets (e.g., accounts receivable, inventory) decreases* cash flow (use
of cash). This is because the company has spent cash to increase these assets.
Decrease in current assets increases* cash flow (source of cash). The company has
received cash by decreasing these assets.
Increase in current liabilities (e.g., accounts payable, accrued expenses) increases* cash
flow (source of cash). The company hasn't yet paid cash for these liabilities.
Decrease in current liabilities decreases* cash flow (use of cash). The company has paid
cash to reduce these liabilities.
2. Cash Flows from Investing Activities (CFI): This section reports cash flows related to the
purchase and sale of long-term assets, such as property, plant, and equipment (PP&E),
investments in securities, and loans made to other entities.
• Examples:
* Inflows (Sources of Cash):
* Sale of property, plant, and equipment
* Sale of investments (stocks, bonds)
* Collection of loans receivable
* Outflows (Uses of Cash):
* Purchase of property, plant, and equipment (capital expenditures or CAPEX)
* Purchase of investments
* Making loans to other entities
3. Cash Flows from Financing Activities (CFF): This section reports cash flows related to how a
company is financed, including debt, equity, and dividends.
• Examples:
* Inflows (Sources of Cash):
* Issuance of bonds or notes payable (borrowing money)
* Issuance of stock (equity financing)
* Outflows (Uses of Cash):
* Repayment of debt (principal only)
* Purchase of treasury
IV. Cash Equivalents:
Cash equivalents are short-term, highly liquid investments that are readily convertible to known
amounts of cash and are so near their maturity that they present insignificant risk of changes in
value because of changes in interest rates. Generally, only investments with original maturities
of three months or less qualify as cash equivalents. Examples include:
• Treasury bills
• Commercial paper
• Money market funds
V. Important Considerations:
• Non-Cash Investing and Financing Activities: Significant investing and financing activities that
do not involve cash are disclosed in a separate schedule or note to the financial statements.
Examples include:
• Acquisition of assets through a finance lease.
• Exchange of debt for equity.
• International Financial Reporting Standards (IFRS): Under IFRS, interest paid and interest
received can be classified as either operating or investing activities. Dividends paid can be
classified as either operating or financing activities, and dividends received can be classified as
either operating or investing activities. GAAP has more specific rules.
• Analyzing the Statement:
• Positive CFO: Generally a good sign, indicating the company is generating cash from its core
business.
• Negative CFI: Common for growing companies that are investing in long-term assets.
• Financing Activities: Monitor debt levels and equity issuances.
• Overall Trend: Look for trends in cash flow over time to assess the company's financial
health.
The Statement of Cash Flows provides a vital perspective on a company's financial
performance, complementing the information provided by the Income Statement and Balance
Sheet. Understanding its structure and components is essential for investors, creditors, and
management alike.
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