What is a Cash Flow Statement?

A cash flow statement is an accounting of how money flows through a company. Though it may be easy to confuse the two, the statement of cash flow is distinct from the income statement. These financial statements are required parts of a public company's quarterly and annual statements. When combined, analysts take the cash flow statement, the balance sheet, and the income statement to determine a firm's overall fiscal health and valuation. The cash flow statement shows investors and other stakeholders how the company generates cash and uses it to pay debts and other obligations. Some firms find that their healthy net income figures are overwhelmed with expenditures. Thus the net income is incapable of overcoming a firm's obligations. Companies with such a weak cash position may need to take a line of credit to pay their obligations, while those with strong cash flow, where net income exceeds expenses, can pay their creditors, employees, and other vendors in a timely fashion.

When created under the direct method, the cash flow statement only reflects actual cash on hand. If the company is expecting revenue in the future, such as monies owed from a credit sale, that is reflected elsewhere. Nor does a direct method cash flow statement reflect obligations in the future, such as balloon payments.An indirect method cash flow statement, on the other hand, reflect future payments and income and thus are more closely tied to the balance sheet and income statement.


  • Operating Activities
    The cash flow statement records the operating activities of a company, which are comprised of any cash credited or deducted from the company's accounts as a result of business operations. These include debits and credits from items such as taxation, sales, employee compensation, rent or mortgage payments, and payments made to suppliers. When scrutinized, the cash flow from operating activities is a reflection of the day-to-day cost of doing business, plus any revenues received. This analysis of the day to day cash flow can help determine how much net cash a firm has.
  • Investing Activities
    To track a company's investment position, accountants rely on the investing activities portion of the cash flow statement. This section reflects items such as asset sales or purchases, loans, and payments related to the sale or acquisition of another corporate entity. Any activity related to a company's operating equipment, assets, or any other investments, including equity positions, are all part of a company's investing activities. In fact, dividend revenue may provide significant cash flow from investing.
  • Financing Activities
    This is a separate item on cash flow statements that reflects a company's cash flow with regards to investing and financing. Some of this information might also apply to the income statement. That is, if a company raises revenue and net cash by means of a loan or issuing a bond, they would notate those funds as a credit on the CFS. Note that receiving money from investors also shows up on the balance sheet as Shareholder's Equity. When the company begins to repay the bondholders, accountants notate that activity as a debit and likely a decrease in liquidity and cash on hand. Investors can review this portion of a company's books to determine the overall health and nature of that entity's cash flow from financing activities. That is, if the company is owed regular payments on loans it has written, then that would be seen as reliable future income. Alternatively, shareholders can review how much the current cash position will be compromised by future outgoing payments that drain coffers in the long term.

Direct vs. Indirect Method

There are two main methods for creating the operating activities section of a CFS: direct and indirect. These methods don't affect the final tally of a company's operating activities, but they present the information in different formats. Under the direct method, only the incoming and outgoing funds available at the time of the statement are included. Any money owed is not included as it is not yet in the cash accounts.

The indirect method, on the other hand, will reflect funds that are owed. For instance, if a company makes a sale for which it has not yet been paid, the value of the sale will be recorded as revenue with this accounting method. However, since no money actually changed hands, the accountants still need to balance the accounts. Thus, the value of the sale is recorded as a debit to accounts receivable.

Accountants prefer this method because it is easier to use information from the balance sheet and income statement to create the cash flow statement. However, the Financial Accounting Standards Board (FASB) recommends the direct method for the CFS because it presents the most accurate, and clearest view of a company's current cash flow status. Analysts may ultimately prefer that financial statements follow the direct method. After all, if their client or employer plans to make a capital investment in a firm, it's important to have a full, detailed view from the financial statements. When the direct method is used, FASB recommends that accountants reconcile the CFS with the balance sheet.

What is it Used for?

The cash flow statement is used to show shareholders and other interested parties how well a company is performing on a day-to-day basis. It reflects how well the company manages its income and outgoing payments, including any cash reserves that can cover unforeseen expenses. Creditors also examine the CFS to determine whether a company is in a position to cover both its daily operations as well as its long-term debts.

Investors will look to a cash flow statement as a way to help determine how the company might perform in the future. Even if a company is operating with a negative cash flow, that could be an indication that they are taking on debt to fund research for a groundbreaking product. On the other hand, a company with fantastic cash flow might be susceptible to future taxes or might even be stagnating in the market. Essentially, when analysts consider the cash flow statement along with the balance sheet and the income statement (statement of profit and loss,) they can arrive at a comprehensive view of the firm's financial health.

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