Purpose of a Cash Flow Statement
The purpose of the cash flow statement is to show where cash is coming from, and where cash is being spent, over a specific period of time (usually a quarterly or annual statement). This is important to determine an entity’s ability to meet its’ needs including paying operating obligations, financing long term assets, and meeting its’ obligations and goals to investors and shareholders.
The cash flow statement is one of three required financial statements of public entities. The other two are the Balance Sheet and the Income Statement.
Format & Components of a Cash Flow Statement
Cash Flow from Operating Activities – is the net amount of cash coming in or leaving from the day to day business operations of an entity. Basically this is the profit (of loss) of the business plus non-cash items such as depreciation. Since accounting profits are reduced by non-cash items (i.e. depreciation) they must be added back to accounting profits to calculate cash flow.
Operating Cash Flow is an important measurement because it tells the analyst about the profitability of an entity’s current business plan and operations. In the long term, cash flow from operating activities must be cash inflows in order for an entity to be solvent and provide for the normal cash outflows from investing and finance activities.
I recommend reading “What is Net Cash Flow?” for a more detailed explanation of the importance of cash flow from operations. Net Cash Flow is the life blood of the entity and its’ future.
Cash Flow from Investing Activities – is the outflow of cash for long term assets such as land, building, equipment, etc. and the inflows from the sale of assets, businesses, or securities. Most cash flow investing activities are cash outflows because most entities make long term investments for operations and future growth.
Cash Flow from Finance Activities – is the cash outflow to the entity’s investors (i.e. interest to bondholders) and shareholders (i.e. dividends and stock buybacks) and cash inflows from sales of bonds or issuance of stock equity. Most cash flow finance activities are cash outflows since most entities only issue bonds and stocks occasionally.
Analyzing a Cash Flow Statement
Understanding where an entity’s cash is coming from and where it is going is crucial to analyzing an entity’s ability to meet its’ obligations and goals. Accounting profits can be deceiving because of non-cash items such as accruing sales revenue before the cash is received or depreciation expense which has nothing to do with cash. The Cash Flow Statement provides a detailed view of cash flow from operations, investing, and financing. This gives the analyst the ability to determine the current solvency and future needs of the entity.
The Cash Flow Statement is my favorite financial statement. What is your favorite?
Related Reading: Investment Portfolio Management
| AAAMP Blog by Ken Faulkenberry | |
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Ken Faulkenberry earned an MBA from the University of Southern California (USC) Marshall School of Business with an emphasis in investments. Ken has 25 years of investment experience and is dedicated to helping people with self-directed investment management through the Arbor Investment Planner. His asset allocation strategies have an outstanding performance record. |
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