A cash flow statement (CFS) is one of the principal types of financial statements. Its primary purpose is to summarize the total amount of cash and cash equivalents (CE) that companies operate. The statement is frequently utilized in business analysis to determine short-term and long-term objectives. Furthermore, the cash flow statement transparently demonstrates investing and financing activities. Alongside the balance sheet and income statement, the cash flow statement is an obligatory component of the companies’ financial reports. Therefore, it is essential to thoroughly inspect the concept and provide illustrative examples of the cash flow statement.
The purpose of the cash flow statement is to summarize all the cash and CE entering and leaving the business. Furthermore, the CFS elaborates on the sources of the income and investments, allowing for a thorough analysis of the expenses. As a result, the CFS provides a clear understanding of the financial condition of the firm. The cash flow statement might also be utilized to predict financial fluctuations within the company. As a result, comprehensive analysis assists in predicting monetary difficulties in the future and, therefore, is a useful tool to determine short-term and long-term goals. These objectives may include debt repayment and investments. Lastly, the availability of the CFS is the legal requirement for business documentation.
The structure of the cash flow statement comprises three distinct sources and uses of cash: operating activities, investing activities, and financing activities. The first type generally refers to the business functions and core operations of the company. They include sales of merchandise and services, rent, salary, income tax, interest payments, contracts with suppliers, etc. The second type covers the investments made by the company. Financing activities refer to cash from investors, banks, payments to shareholders, and other types of financing operations.
Operating activities cover sources and uses of cash from core operations and business functions of the company. In general, they include sales of goods and services, interest payments, rent, external expenses, salary, payment to suppliers, compensations, and property depreciation. However, it is essential to understand that operating activities may be reflected in different ways depending on the method of CFS calculation. The difference between direct and indirect models will be discussed in the consequent slides. Nevertheless, despite the chosen method, operating activities demonstrate how much cash the company generates from its main functions and services.
Investing activities cover sources and uses of cash from investments. In general, they include the purchases of property, equipment, marketable securities, and other assets. However, investments also cover loans to vendors, payments regarding mergers and acquisitions, and proceeds from incentives. In other words, investing activities cover the changes in the assets of the company. In most cases, investing activities are reflected as ‘cash out’ in the cash flow statement since most of the activities are purchases of equipment and properties.
Financing activities cover sources and uses of cash in financing operations, such as payment of dividends, repayment of debts, and loans from banks. If the cash repaid as debts and dividends exceed the loans, then financing activities are identified as ‘cash out’. On the other hand, if the raised capital exceeds the repaid debt, financing activities are reflected as ‘cash in’.
Cash flow calculation
The CFS is calculated by adding and subtracting values from the net income based on the three mentioned activities. The investing and financing activities are always calculated the same way; however, operating activities are calculated based on the particular model. The two methods of the CFS calculation are direct and indirect. There are several differences between the direct and indirect methods that primarily concern the presentation of operating activities. Both models are viable options that transparently demonstrate the financial condition of the company. Nevertheless, most companies prefer the indirect model due to the simplicity of the framework and several differences that will be explained next.
Comparison of the Methods
The key difference between the direct and indirect methods is how they illustrate the operating activities of the company. The direct model lists all the financial operations transparently, including cash payments, receipts, salaries, etc. On the other hand, the indirect model uses the net income as a base and adds or subtracts values from it. As a result, this method utilizes non-cash activities, such as depreciation and non-cash profit operations. The direct and indirect models are reflected differently in the operating activities of the cash flow statement. Additionally, there are some differences in the preparation of the statement. For instance, while the direct method is highly accurate and does not require any adjustments, it is slow and requires significant effort to make. On the other hand, the indirect method is not as precise and illustrative as the direct model; however, it is quick and easy to make. That is why most companies utilize the indirect method of calculation.
Having examined the primary objectives, functions, and structure of the cash flow statement, it is essential to take a closer look at the examples to grasp the concept better. The first example is a highly simplified artificial cash flow statement with a basic structure. It implements an indirect method of calculation and includes cash from operations, investing, and financing. The notions ‘increase/decrease’, as opposed to specific processes, transparently demonstrate the usage of the indirect method. The increases in cash are illustrated by mere numbers, while the decreases are shown by numbers in the parentheses. The business operations are the source of $ 2 012 000 which means that the current business strategies and core operations are profitable. Therefore, the CFS transparently demonstrates that the current company is a promising subject to investments. Having gained a sufficient amount of finances, the company spent $500 000 on the purchase of new equipment, which demonstrates the readiness of the company to innovate the core operations. The total amount of cash earned in the financial year is $1 522 000, and it implies the success of the current business strategies and positivity of the cash flow statement.
The second example concerns a real-life scenario in an agricultural setting. It is a simplified version of the cash flow statement that demonstrates the financial condition of a ranch. The structure deviates from the basic one ‘operating-investing-financing activities’ and has two primary sections ‘cash inflows’ and ‘cash outflows’. While the organizational formatting is different, the cash flow statement fulfills its primary purpose, which is to summarize all the cash and cash equivalents flowing in and out of business. Another defining feature of the current CFS is that it demonstrates both annual and monthly calculations, which might be particularly beneficial for small to medium-sized companies. Unlike the previous example, the CFS utilized the direct method of accounting, which is represented by the entries (cash payments instead of adding and subtracting values). It is a thoughtful decision to use the direct method in the case of small to medium-sized companies since it does not require much time and effort to prepare a CFS for such organizations. Lastly, the CFS demonstrates a positive outcome due to an increase in the ending cash balance.
Example 3. Operating activities
As mentioned before, the presentation of operating activities is implied by the calculation method. In the case of the Amazon CFS, it is the indirect method. Such entries as depreciation, compensation, operating expenses, change in liabilities are non-cash expenses that represent both decreases and increases of the income. The positive outcome and the vast increase in the net cash transparently demonstrate the improving financial state of the company.
Example 3. Investing activities
Investing activities primarily refer to purchases and proceeds of equipment and property. In this particular case, the investments into property, equipment, software, website development, and marketable securities comprise the major part of the used net cash. However, the company has received a considerable amount of money from sales and maturities of marketable securities. Investing activities primarily demonstrate a decline in the net cash due to the nature of investing; and it is also true in the case of Amazon.
Example 3. Financing activities
Financing activities cover the debt (short-term and long-term), capital lease obligations, and finance lease obligations repayments. However, the report also shows the increase in the income due to proceeds from issuing short-term and long-term debts. In this particular case, the financing activities show a decline in the net cash; however, in a large number of situations, financing activities are associated with the capital raise due to loans from banks and cash from investors.
Example 3. Outcomes
The last section of the CFS includes the foreign currency effect on cash, the net increase or decrease in cash, and the amount of money at the end of the fiscal year. The current report displays the positive net income change for every financial year, indicating the stable economic condition of the company. Furthermore, the cash flow statement presents the information for three consecutive years allowing for direct comparison and determining the success of the company’s business strategies.
The cash flow statement is a highly impactful summary that allows to thoroughly analyze the financial well-being of the company. It is implemented by the companies not only to determine short-term and long-term goals but also to identify any potential financial difficulties. Furthermore, it is a legal requirement to include the cash flow statement in the annual financial reports; therefore, it is necessary to understand the structure and key features of the CFS.
Amazon. (2020). Annual report. Web.
Clawson, S. (2020). Building your ranch cash flow statement. OSU Extension, 40(2), 1.
Murphy, C. (2021). Understanding the cash flow statement. Web.