By Scott Beaver | Sr. Product Marketing Manager
Oracle NetSuite
One question is fundamental to any business: How much money is coming in versus how much is going out? A cash flow statement answers that and provides a clear picture of whether a company has the cash it needs to pay its debts and fund operating expenses over a set timeframe. It’s one of the most important sources of insight into a company’s financial health.
A cash flow statement, also known as a statement of cash flows, is a financial statement that documents the cash and cash equivalents a company generates and spends over a specific period. Cash flow statements reveal a business’s liquidity, help evaluate changes in assets, liabilities and equity, and make it easier when analyzing operating performance.
The cash flow statement serves as a bridge between the income statement and the balance sheet. There are four key reasons why a cash flow statement is important:
All publicly traded companies must file financial reports and statements with the Securities and Exchange Commission (SEC). The cash flow statement is one of three critical documents, along with the balance sheet and income statement, included in SEC filings. It provides information about cash receipts, cash payments and the net change in cash resulting from a company’s operating, investing and financing activities.
Investors look to the cash flow statement for insights into a company’s financial footing. Meanwhile, creditors can use the cash flow statement to gauge liquidity and determine whether a company can fund its operating expenses and pay off its debts.
A cash flow statement consists of three key components:
Additionally, the cash flow statement may include disclosure of non-cash activities when prepared under generally accepted accounting principles (GAAP)—items like fixed asset depreciation, goodwill amortization and the like.
There are two methods of cash flow statement preparation: direct and indirect. The best choice for your business depends on how much detail you need to include in your statement, as well as how much time you are willing to dedicate. While both methods are GAAP-approved, the International Accounting Standards Board (IASB) prefers the direct reporting method. However, most small businesses use the indirect method.
The main difference between the direct method and the indirect method of presenting the statement of cash flows (SCF) involves the cash flows from operating activities. There are no differences in the cash flows from investing activities and the cash flows from financing activities under either method—the real difference lies in the operating activities.
When it comes to the balance sheet, any changes in accounts receivable must be reflected in cash flow. A decrease in accounts receivable implies that more cash has entered the company from customers paying off credit accounts. The amount accounts receivable decreased is added to the company’s net sales. However, if accounts receivable increases, the amount of the increase must be deducted from net sales. That’s because, while accounts receivable amounts count as revenue, they are not cash.
When inventory increases, it indicates that a company has spent money on raw materials. If cash were used in the purchase of that inventory, the increase would be deducted from net sales. On the flip side, if there were a decrease in inventory, that would be added to net sales. If the inventory was purchased on credit instead of cash, the balance sheet would reflect an increase in accounts payable, and that year-over-year increase would be added to net sales.
Investing activities account for the income of a company’s investments. More specifically, these activities may include an asset purchase or sale, interest from loans or payments related to mergers and acquisitions.
Cash changes from making investments are considered use items, because cash is used on expenditures such as property, equipment or short-term assets. But when an asset is divested, that transaction is considered a source and is listed in cash from investing activities.
Financing activities involve both cash inflows and outflows from creditors. This category comprises the money that comes from investors or banks, dividend payments, and goes out for stock repurchases and the repayment of loans.
Not all financing activities involve the use of cash, and only activities that impact cash are reported in the cash flow statement. Non-cash financing activities include the conversion of debt to common stock or issuing a bond payable to discharge the liability.
A business’ financing activities shed light on its overall financial health and goals. For example, positive cash flow from financing activities is indicative of growth and expansion. More money flowing into a business signifies an increase in business assets. Meanwhile, cash outflows from financing activities can signify improved liquidity. It may mean that a company has paid off long-term debt or made a dividend payment to shareholders.
In general, a positive cash flow statement is a sign of a healthy company. And yet a negative cash flow statement is not in itself cause for alarm. It may mean a business is new and has spent a lot of money on property or equipment. Or, it could mean the business is in growth mode.
For example, Netflix had a negative cash flow for years while the company increased spending on original content. It was a gamble, but some investors saw the strategy as a positive. More original content meant the business would be better equipped to compete with other streaming services and TV networks.
The cash flow statement serves as a bridge between the income statement and the balance sheet by showing how cash moves in and out of a business during a specific period. The balance sheet involves a company’s assets and liabilities from one period to the next while the income statement covers expenses and income over time.
Finance can reference both the balance sheet and the income statement while preparing a cash flow statement. The net cash flow in the cash flow statement between periods should equal the change in cash between consecutive balance sheets of the period that the cash flow statement covers. The cash flow statement is formulated by subtracting non-cash items from the income statement.
Below is an example of a cash flow statement for Macy’s department stores.
Cash flow statement |
|
Cash flow from operating activities |
|
Net income | 564M |
Additions to cash | |
Depreciation | 981M |
Increase in accounts payable | -277M |
Subtractions to cash | |
Increase in accounts receivable | -9M |
Increase in inventory | 75M |
Net cash from operations | 1.3B |
Cash flow from investing | |
Purchase of equipment | -657M |
Cash flow from financing | |
Notes payable | 0 |
Cash flow for month ended January 31, 2020 | 643M |