What is Cash Flow Statement Definition & Example

Tally Solutions |Updated on: May 6, 2022

What is a Cash Flow Statement?
How does a Cash Flow Statement work?
Why do Cash Flow Statements matter?

What is a Cash Flow Statement?

To efficiently manage your business, you must be aware of the various financial statements. To assess and make crucial business decisions for positive outcomes in the future, a business owner must closely evaluate his company’s financial health. Cash flow statement is one such financial statements, which will help you draw a perfect picture of the cash inflow and outflow within your business.

The cash flow statement is a financial statement that summarizes the amount of cash and cash equivalents entering and leaving a company. Management of a company’s cash position eg: how well a company generates cash to pay its debtors and fund its operating expenses, is what a cash flow statement will help an entrepreneur measure.

The cash flow statement complements the balance sheet and income statement and is a mandatory part of a company's financial reports since 1987.

How does a Cash Flow Statement Work?

It is imperative to note that a cash flow statement is not similar to net income which includes transactions that did not involve actual transfers of money (depreciation is common example of a noncash expense that is included in net income calculations but not in cash flow calculations). A cash flow statement is primarily calculated by assessing three aspects, Operating Activities, Investing Activities and Financing Activities.

Cash flow from operating activities are generally calculated according to the following formula:

Cash Flows from Operations = Net income + Noncash Expenses + Changes in Working Capital

Often even the most profitable and organized firms can fail to adequately manage their cash flow which could in turn, affect their financial health in the future. Keeping a close tab on the company’s working capital will solve half your cash flow problems, as it will help you draw a clear picture of your receivables and payables. Careful assessment of your working capital will take of your operational costs automatically. Understanding the cash inflow and outflow will enable you to plan for your operational activities even better. For example, accounts receivable is a noncash account. If accounts receivable goes up during a period, it means sales are up, but no cash was received at the time of sale. In such cases, the cash flow statement deducts receivables from net income because it is not cash. The cash flows from the operations section can also include accounts payable, depreciation, amortization, and numerous prepaid items booked as revenue or expenses, but with no associated cash flow.

Cash flow from investing activities primarily reflect the company's purchases or sales of capital assets (that is, assets with a useful life of more than one year that appear on the balance sheet). It is important to note that companies have some leeway about what items are or are not considered capital expenditures, and the investor should be aware of this when comparing the cash flow of different companies.

Cash flow from financing activities typically reflect the company's purchase or sale of stock and any proceeds from or payments on debt financing. The measure varies with the different capital structures, dividend policies, or debt terms companies may have.

Why do Cash Flow Statements matter?

Cash flow statements have several benefits, if maintained diligently and regularly. Apart from giving you insights about the cash inflow and outflow, cash flow helps companies expand, develop new products, buy back stock, pay dividends, or reduce debt.

Cash flow statements will also give you how successful your business is, in terms of growth. You can evaluate your goals and plan the future of your company and assess the liquidity risks that your company might run into. It is also imperative to note, that having negative cash flow for a time is not always a bad thing. For example: If a company is a net spender of cash for a time because it is building a second manufacturing plant, this could pay off in the end if the plant generates more cash. On the other hand, if the company has a negative cash flow because it made a poor acquisition or other investment, then the long-term benefit might not be there.