The Financial Trinity: Statement of Cash Flows

Roni's guide to tackling a cash flow statement.

Aug 02, 2023

A cash flow statement is a financial report that shows the inflows and outflows of cash in a business over a specific period of time. It provides an overview of how much cash a company has generated and how it has been used.

The statement is divided into three sections: operating activities, investing activities, and financing activities.

Components of the statement

Cash Flows from Operations

These represent the cash inflows and outflows arising from normal day-to-day trading activities. These activities may include:

Amounts from trade receivables (Inflow)
Cash sales (Inflow)
Rent (Outflow)
Wages (Outflow)

Normally, ‘operating activities’ provide positive cash flows and, therefore, increase the business’s cash resources.

Cash Flows from Investing

These include cash inflows and outflows resulting from the purchase or sale of long-term assets such as:

Property, Plant, and Equipment
Investments made in loans or shares in another company

Investing activities typically cause net negative cash flows. This is because many non-current assets either wear out or become obsolete and need to be replaced.

Non-current assets may be sold which would give rise to positive cash flows. In net terms, however, the cash flows are normally negative with the cash spent on new assets far outweighing that received from the sale of old ones.

Cash Flows from Financing

These represent cash inflows and outflows relating to the long-term financing of the business. Examples may include:

Issuing/repaying debt
Paying dividends
Issuing new stock

Financing can go in either direction, depending on the financing strategy at the time.

Since businesses seek to expand, there is a general tendency for this area to lead to cash coming into the business rather than leaving it.

Layout of the statement

The net earnings figure is derived from the income statement. This highlights another overlap between the main financial statements.

Importance of the statement

Here are several reasons why the cash flow statement is important:

Assessing Liquidity:
Helps evaluate a company's ability to meet its short-term obligations. By analyzing the operating cash flows, investors and creditors can determine if a company generates sufficient cash from its core operations to cover expenses, pay off debts, and invest in growth opportunities.
Managing Cash:
Allows businesses to track and analyze their cash inflows and outflows, helping them understand patterns and timing of cash flows. This information enables companies to anticipate and plan for cash shortages or surpluses, optimize cash utilization, and make informed financial decisions.
Identifying Cash Sources and Uses:
It highlights the sources of cash, such as customer payments, investment income, or loans, as well as the uses of cash, such as payments to suppliers, operating expenses, or debt repayments. This information assists in identifying areas where cash is generated or consumed, enabling management to allocate resources effectively.
Evaluating Investment and Financing Activities:
It reveals the cash spent on acquiring or selling assets, such as property, equipment, or investments. It also reveals the cash repaid through debt issuance, equity financing, or dividend payments. This knowledge helps assess the effectiveness of investment strategies and the ability to fund operations and growth initiatives.
Enhancing Financial Analysis:
Complements other financial statements, such as the income statement and balance sheet. By comparing cash flows with profitability and balance sheet metrics, analysts can gain insights into the quality of earnings, working capital management, and overall financial stability.

In summary, the cash flow statement is vital for assessing liquidity, managing cash effectively, and enhancing financial analysis. It provides valuable information for shareholders to evaluate the financial health and sustainability of a business.