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There are 5 posts in this series:
- Personal Financial Statement
- Balance Sheet
- Income Statement
- Cash Flow Statement
- Glossary of Key Financial Terms
A Cash Flow Statement reports how much cash a business generated or consumed over a period of time. It is typically produced by your accounting software, as all Income Statement and Balance Sheet accounts are involved in the analysis. A business can have a positive Net Income, but still be consuming cash - which can lead to business failure, including bankruptcy.
Cash Flow Statements have three main sections:
- Cash Flows from Operations
- Cash Flows from Investing - includes purchases or sales of physical assets, securities
- Cash Flows from Financing - includes changes in debt, outstanding equity, and payment of dividends
Cash Flows from Operations starts with Net Income from the Income Statement, because this figure often accounts for the majority of a business’ cash generation or consumption. It then adds back “non-cash expenses” that were on the Income Statement, such as Depreciation or Amortization. These items reflect past expenditures that are being spread out over a number of years, so the cash they describe actually left the company before the period being reported on.
Next, it looks at the many Balance Sheet accounts whose balances are affected by the normal operations of the company. Many may only have a small impact on cash flow, but ones that change significantly between the beginning and end of the period can have a significant impact on the company’s cash flow. Balance Sheet accounts that often have a noticeable impact on Cash Flow from Operations include:
- Accounts Receivable - an increase means you have less of your “profits” as cash in hand
- Inventory - an increase means that you have less cash, having spent it on inventory
- Accounts Payable - an increase means you owe your vendors more, leaving more cash in hand
Cash Flows from Investing shows the effect on cash of purchases and sales of physical assets. Purchasing a building or machinery will reduce cash. But if a new loan is obtained to help fund the purchase, there will generally be a smaller net effect on cash. Purchasing or selling assets often involves obtaining new loans or repaying old ones, in which case the transaction may end up affecting both the Investing and Financing sections of the Cash Flow Statement.
Note that cash flow is reduced by both a net increase in an asset account (other than cash) or a net decrease in a liability account. Therefore, such numbers are shown in parentheses on a cash flow statement. A simple Cash Flow Statement is shown on the next page.
Cash Flow Statements explain why your cash balance(s) changed as they did. Sometimes the explanation is straightforward, and sometimes it can be complicated. If your cash balance is growing, that’s a nice problem to have. However, if it is shrinking at a rate that causes concern, the Cash Flow Statement is helpful in figuring out why that is happening. Knowing why it is happening allows you to plan better and hopefully resolve the situation.
The following resources provide additional information:
What Is a Cash Flow Statement? (Investopedia)
How to Read a Cash Flow Statement (Harvard Business School)
Learn Accounting For Free (Accounting Coach)
To ask questions and/or learn more about financial statements, register for a “Financial Statements” workshop in the SCORE workshop calendar or request to meet with a SCORE Mentor (a free service).
