Do You Understand Your Cash Flow Statement?

In many businesses, income and cash flow are not always the same, which leads to the need for a cash flow statement showing the exchange of money between a company and the outside world over a period.

The cash flow statement reconciles opening balance of cash (as opposed to non-cash items such as credit sales) at the start of the period with the closing balance of cash at the end of a period.

Managing the Cash

Understanding cash management is critically important for a person running a business. One must be a good manager of cash to build a business successfully because cash is vital to the operation of every business.

The final information one looks for in the cash flow statement is the net increase or decrease in cash for the period.

This information is very important from a financial point of view. Financial analysts focus this information to judge the ability of a business to generate cash. The information is also of vital importance for the person in business because it tells him/her about their business’ liquidity strength.

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The Cash Flow Statement Answers Several Questions for You

The cash flow statement aids the businessperson to answer vital questions like: Where was money obtained? Where was money put and for what purpose? Additionally, the information contained in the cash flow statement is important to answer many critical questions, such as:

  • Is my business growing, or simply maintaining its competitive position?
  • Will my business be able to meet its financial obligations?
  • Where did my business obtain funds?
  • What use was made of net income?
  • What is the internal capacity of my business to generate funds?
  • How was the expansion in plant [do you mean plant expansion?] financed?
  • Is my business expanding faster than it can generate funds?
  • Is there a balance in the dividend policy and operating policy of my business?
  • Is my business’ cash position sound?

Cash Flow Patterns

The pattern of cash utilization can determine a firm’s success or failure. A businessperson must control his/her company’s cash flow so that bills can be paid on time and extra money can be put into the purchase of inventory and new equipment or invested to generate additional earnings.

The statement of cash flow reports on the company’s cash movements during a period, categorizing them into three areas that cash flows through a business from its operating, investing and financing activities.

Therefore, cash flow statements generally have three main areas (cash flows):

  1. Operating activities
  2. Investing activities
  3. Financing activities

The cash flow statement discloses cash in these specific categories. The most important of the flow categories in a cash flow statement is cash from operating activities. This category is the primary focus of the person operating the business. The cash flow from operations must be positive (net inflow) to make the business viable in the future and to make it an attractive investment for the person running the business.

Each part reviews the cash flow from one there particular type of business activity. See the following Cash Flow Statement illustration:

Cash flow statement2



A cash flow statement such as this, categorized by three separate types of cash flow, give a business a holistic view of total flows into and out of the business. Cash flow statements are therefore fundamental tools to use when making decisions about a company’s cash management.

Cash Flow Statements Change with Time

A cash flow statement is a “flow” statement. It is not a snapshot like a balance sheet. It shows changes over time rather than an absolute dollar amount at a particular point in time. Information from a company’s balance sheet and income statement is used to prepare a cash flow statement. It is reordering of information from a company’s balance sheet and income statement in order to provide a different view of the business.

Now, let’s look at each section, specifically,

Cash Flow Statement Operating Activities

Operating activities are defined as the company’s primary business activities, for example the production and delivery of goods and services. They reflect the cash effects of transactions, which are included in the final determination of net income. These activities basically include all activities not classified as either financing or investing activities.

Cash flow from operating activities is the first part of a cash flow statement. It analyzes a company’s cash flow from net income or losses.

Typically, this section of the cash flow statement reconciles the net income with the actual cash the company received from or used in its operating activities. To do this, it adjusts net income for any non-cash items like depreciation expenses and adjusts for any cash used or provided by other operating assets and liabilities.

As discussed earlier, the most important aspect of cash flow in the statement is cash from operating activities (a.k.a. cash from operations).

The cash flow from operations must be positive (net inflow) to make the business viable in the future and to make it an attractive investment for the person running the business.

Cash Flow Statment Investing Activities

This is the second part of a cash flow statement. It shows the cash flow from all investing activities, which generally includes purchases or sales of long-term assets, such as plants, properties, and investment securities, etc. For example, if the Learning Company buys a piece of machinery, its cash flow statement would reflect this activity as a cash outflow from investing activities.

The cash flow is categorized as investing activity because it used cash for investing in the business. Similarly, if the company decided to sell off some investments, it would also be considered an inflow from investing activities. This is because it provided the business with cash.

Cash Flow Statement Financing Activities

This is the third part of a cash flow statement. Financing activities show the cash flow from all financing activities. Financing activities include the activities relating to the receipt and repayment of funds provided by creditors and investors. Examples of this would be in the issuance of debt or equity securities, the repayment of debt, and the distribution of dividends.

This means the sources of cash flow include cash inflow resulting from sale of stock and bonds or borrowing. Likewise, the repayment of a bank loan would generate cash outflow in this category.

Business people who intend on expanding their venture need cash which can be done through equity or borrowing – both are financing activities. When a company issues stock or borrows money, it receives cash. As we stated above, the two cash receipts are from financing activities.

IMPORTANT: When you borrow from a bank, you will have to pay interest (i.e. cash outflow in future.) An unwise investment or use of these financed funds in a non-productive investment activity may trap a business in a future regular pattern of interest payments. In extreme situations, this may even result in bankruptcy.

Fundamentals of Financial Statements, 4 Part Series