Cash flow statement

August 13, 2016

The cash flow statement provides information beyond that available from the income statement, which is based on accrual, rather than cash accounting. The cash flow statement provides the following:

  • Information about a company’s cash receipts and cash payments during an accounting period.
  • Information about company’s operating, investing and financing activities.
  • An understanding of the impact of accrual accounting events on cash flow.

The cash flow statement provides information to assess the firm’s liquidity, solvency and financial flexibility. An analyst can use the statement of cash flow to determine whether:

  • Regular operations generate enough cash to sustain the business.
  • Enough cash is generated to pay off existing debts as they mature.
  • The firm is likely to need additional financing.
  • Unexpected obligation can be met.
  • A firm can take advantage of new business opportunities as they arise.

The cash flow statement reconciles the beginning and ending balances of cash over an accounting period. The change in cash is a result of the firm’s operating, investing and financing activities as follows:

           Operating cash flow

          + Investing cash flow

   + Financing cash flow

          = Change in cash balance

    + Beginning cash balance

         = Ending cash balance

It is important to understand that net income based on accrual accounting is not the same thing as cash earning. When the timing of revenue and expense differs from the receipt or payment of cash, it is reflected in change in balance sheet accounts.

For example, when revenues (sales) exceed cash collections, accounts receivable increase. The opposite occurs when cash collection exceeds revenues; accounts receivable (asset) decrease. When purchases from suppliers exceed cash payments, accounts payable (a liability) increase. When cash payments exceed purchases, payables decrease.

Investing activities typically relates to the firm’s non-current assets, while financing activities typically relate to the firm’s non-current liabilities and equities.  

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