Statement of Cash Flow

Business owners, creditors, and investors use the statement of cash flow to analyze the financial health of the business.

Business owners use the statement of cash flow to measure such activities as whether or not there is adequate cash on hand to pay debts, order inventory, purchase assets, or expand operations.

Creditors use the statement of cash flow to determine the solvency of the business, or the ability of the firm to pay its debts as they mature.

Investors use the statement of cash flow to determine how much cash is generated from operations to fund capital investments and pay down debt, in addition to the ability of the company to adapt to changing economic conditions, called financial flexibility.

Understanding the Statement of Cash Flow and Cash Flow Analysis

The statement of cash flow classifies the inflow and outflow of cash as cash flow operating activities, cash flow investing activities, and cash flow financing activities.

1. Cash flow from operating activities refers to the cash generated or consumed from the primary operations of the business.

   • Collecting cash from customers is an example of a cash inflow from operating activities.
   • Payments to suppliers, employees, or paying rent are examples of cash outflows from operating activities.

2. Cash flow investing activities refers to cash inflows and outflows from investments. Investing activities include lending money with interest, buying and selling assets, and buying and selling investments (e.g. stocks and bonds).

   • Collecting on a loan, selling assets, or selling investments are examples of cash inflows from investing activities.
   • Making a loan for cash, purchasing assets, or purchasing investments are examples of cash outflows from investing activities.

3. Cash flow financing activities are those activities that allow the company to borrow money or obtain other forms of financing for operating the business.

   • Borrowing money or issuing stock to raise cash are examples of cash inflows from financing activities.
   • Repaying loans or paying dividends on stocks issued are examples of cash outflows from financing activities.

Each Statement of Cash Flow Section Answers the Following Questions:

Cash Flow Operating Activities If a company has profitable operations, why is it short on cash? If a company is operating at a net loss, why does it have a surplus of cash? Cash Flow Investing Activities Is the company using cash to acquire new equipment? Is the company investing cash to expand operations? Is the company obtaining cash from selling assets? Is the company loaning cash? Where is the company investing its cash? How much and where? Cash Flow Financing Activities Is the company financing asset purchases? How much of the asset is financed? Did the company use cash to pay off any of its outstanding loans used to finance the business?

Answers to these questions do not appear on the income statement and are not easily determined by analyzing the balance sheet.

Over the life of a company, the net cash increase or decrease will equal the total reported net income or loss. However, because the income statement and the balance sheet use the accrual accounting method and the statement of cash flows uses the cash accounting method, over the short-term net income will not equal cash flow.

Quality of Earnings refers to how closely income correlates with cash flow. The higher the correlation between net income and cash flow, the higher the earnings quality.

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