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- A cash flow statement is one of three key documents used to determine a company’s financial health.
- Cash flow statements provide details about all the cash coming into and exiting a company.
- A cash flow statement alone will not show all the necessary financial data to accurately analyze a company.
- Read more stories from Personal Finance Insider.
Companies with stocks that trade on public exchanges are required to periodically disclose a wide range of documents with detailed information about their operations. The cash flow statement is one of the most important to understand.
What is a cash flow statement?
Cash flow statements are financial accounting statements that provide a detailed picture of the movement of money through a company — both what comes in and what goes out — during a certain period of time.
Using the information contained in a cash flow statement, business owners, shareholders, and potential investors can see how much cash a business is bringing and how much it’s spending in a given period. In conjunction with other documents, cash flow statements can help you understand how financially healthy a company is.
Usually, cash flow is divided into three main categories: operations, investment, and financing.
“Cash flow statements really just show business operations’ impact to cash,” says Dondrea Owens, CPA and founder of The Creative’s CFO.
A company’s cash flow statement is one of three key reports that investors and other interested parties use to determine its financial performance. The others are the income statement and balance sheet. Together, they depict a company’s finances. In the US, the Securities Exchange Commission (SEC) requires publicly traded companies to provide them.
Though all three documents deal with a company’s money, they look at it from different angles. “We find that a lot of folks start with the balance sheet and the income statement,” says Meredith Tucker, CPA at Kaufman Rossin. “And yet, I think the cash flow statement is one of the most helpful.”
Why are cash flow statements important?
Cash flow provide important context to information that might not be apparent on a different financial statement. If a business makes a sale to a customer, that revenue often goes on an income statement and contributes to the company’s overall profit or loss. However, if an invoice isn’t due right away or the company extends a line of credit to the customer, the actual cash may not hit the company’s bank account for months. This is why understanding cash flow is so important.
In general, cash flow statements show a company’s ability to operate. If an organization doesn’t have enough cash to pay its expenses during a given period, it may not matter how many realized sales it’s made.
“From an investor standpoint, I want to know how a company is using the money I’m going to give them,” Tucker explains. This is another reason cash flow statements can be important. They don’t just show how much money was spent, but where it was spent.
“Are they diverting cash to repay debt? Are they distributing it out to shareholders? Are they losing money because they’re extending more and more credit to their customers?” Those are the kinds of things we want to see,” Tucker says.
How to read a cash flow statement
Reading a cash flow statement is an important skill for anyone who wants to understand the financial health of a company. Cash flow statements start with the amount of cash an organization had at the beginning of an accounting period and finish with the amount of cash the organization has at the end of the period. Everything in the middle details cash transactions as money entered and left the company.
In general, this middle portion will be separated into three distinct categories: operating activities, investment activities, and financing activities. Within each category, line items show where money went or came from. Not every company will have the exact same line items on its cash flow statement, which Owens says is normal and not a cause for concern. Usually, money entering the company will be written as a numeral, and money exiting the company will include parenthesis around the amount.
Net cash flow from operations
"The operating section is going to tell you about all the run-of-the-mill things that affect cash," Tucker says. These are the types of cash activities many people automatically associate with running a business: income from customers, wages to staff, inventory purchases, and income taxes, for example.
In the statement above, you can see that within the last year, $975,000 was paid to the company from customers, and the organization spent a total of $563,050 on all operating expenses. In this example, the business' operating costs come from inventory purchases, operating and administration expenses, wages, interest, and income taxes. The net cash flow from operations lines shows the difference between these two numbers, in this case, $411,950.
Net cash flow from investing
The net cash flow from investing line shows the change in cash flow from all investing activities. In a business, investment activities may include the purchase or sale of physical assets, investment in securities, or the sale of securities.
In the example above, the business only had two items that could be categorized as investment activities: selling property or equipment for $33,600 and purchasing property or equipment for $125,000. In this category, the company spent $91,400 more than it brought in, making that number its net cash flow from operations.
Net cash flow from financing
The final category on the balance sheet shows all cash transactions that had to do with financing activities. Things that would go in this category include activities that have to do with debt, equity, or dividends. In our example above, the company paid $38,000 and $52,000 to loan repayments and dividends, respectively. The organization didn't bring in any money through financing activities, so the net cash flow from financing is negative $90,000.
Net increase in cash
The net increase in cash line shows the total change from the three subsections. With $411,950 coming in from operations, $91,400 leaving from investing, and $90,000 leaving from financing, the business had a net cash increase of $230,550. Adding this number to the $19,800 the company had at the beginning of the year, the organization ends 2021 with $250,350 in cash.
What is negative cash flow?
Negative cash flow appears when a company spends more than it generates in a certain period. A company may have an overall negative cash flow or any one of the sections may have negative cash flow, as the previous example shows in the investing and financing sections.
"Negative cash flow isn't always bad," Owens says. "Companies do go through growth phases where they are spending money to make money." As long as the negative is planned, it's not an immediate red flag.
Negative cash flow could also come down to a timing issue. "An accounting firm is a perfect example," Tucker explains. The busy season for accountants is often the beginning of the year when taxes are due, but most of those receivables won't be paid immediately. Though the business is generating revenue, the cash isn't in the account yet.
On the other hand, if there is a pattern of cash flow issues, that could be a warning sign that the company isn't managing its money well. If you see a negative cash flow, it's worth looking into the reason to determine if it's cause for concern or not.
What to watch for in a cash flow statement
Though a cash flow statement can't tell you everything about a company's financial viability, there are some things to watch out for in them that can be particularly telling.
"A green flag for me is if there is positive cash flow coming from operations," Owens says. "That's a good sign that the company is generating cash just from its operations."
On the flip side, Owens explains that negative cash flow from operations could be an indicator that something isn't going well with the company and might require additional research.
Owens also recommends looking at the financing section, particularly to see if it's bringing in most or all of its cash from loans or other sources of financing.
"This isn't always a bad thing," she says. For example, in a startup it might be normal. But if most of the money is coming from financing, it's worth taking a second look, especially if the money will eventually need to be repaid.
In general, the more cash that comes from operations, the better, Owens says.
Cash flow statement vs. income statement vs. balance sheet
Though cash flow statements include plenty of helpful information, they alone will not tell you a company's entire financial picture. They work best when analyzed in conjunction with the income statement, which shows its profit or loss, and balance sheet, which details assets and liabilities.
At times, one statement may answer a question the other poses. For example, if you look at a company's balance sheet from one year to the next and see its cash assets went from $1 million to $500,00, at first glance, this could look alarming. But, if you follow up with the cash flow statement, you may see the money was used as part of an investing activity and went toward the purchase of another facility that could increase the profitability of a company long-term.
"Make sure you understand the story that these financial reports are presenting to you," Tucker says. "You really need the interplay to interpret the full story."
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