Apart from the statement of profit and loss and the balance sheet, there is another important financial statement known as the cash flow statement. If we want to know all the transactions that have taken place during the year, we will need to look at the cash flow statement. It provides a detailed explanation of how and why the cash balance for the company changed over a period.

Cash flow is a movement (receiving or spending) of cash into or out of the company. When the total cash that the company received is greater than the total cash that it spent, the company is said to have a positive cash flow. When the total cash that the company spent is greater than the total cash that it received, the company is said to have a negative cash flow. A company’s cash flow for a given period is listed in the cash flow statement.

Cash flow statements are used by many groups. Current and future investors are interested in how the business is doing and want to know how the cash is being used—or flowing. Creditors are concerned about being paid and want to know about previous cash receipts and payments. Every stakeholder wants to understand how the cash balance stated in the balance sheet came to be. The cash flow statement is useful in evaluating past performance and making future decisions based upon this past performance. 

The cash flow statement reports movements of cash by the company. If the company has $100 in cash at the beginning of the year (date A) and $500 in cash at the end of the year (date B), the cash flow statement will explain what caused the $400 increase.

The purpose of the cash flow statement is to explain what caused the difference between the amount of cash the company had at the beginning of the period (date A) and the amount of cash it had at the end of the period (date B). The difference could also be 0.

As stated earlier, the term “cash flow” reflects a movement of cash: 

• When a company receives cash, it is said that it flowed into the company.
• When a company makes a payment of cash, it is said that it flowed out of the company.

The company usually keeps most of its cash in the bank—in a current account or short-term deposit—and a small amount in the company treasury. When discussing cash activity in a company, it is important to distinguish between two important concepts:

• Movement of cash refers to both the entry and exit of cash.  
• Net movement of cash presents the difference between the total cash that entered and the total cash that exited.

For large companies, most cash flow statements will be prepared using the indirect method. This is a method of generating the cash flow statement that starts from net income and then makes adjustments to net income to convert it to cash flows.

General Features

The cash flow statement concerns three spheres of activity: operating activity, investment activity and financing activity. Movements of cash take place in each of these spheres during the period. Movements of cash in each sphere are independent of activity in the other spheres. Movements of cash and the net movement of cash (entry of cash minus exit of cash) are listed separately in each sphere. The sum of the net movements of cash in each of the three spheres of activity reflects the difference between the company’s cash at the beginning of the period and its cash at the end of the period.

Cash flows from operating activities are transactions that affect the net income (loss) of the company. The profit and loss account reflects a profit or a loss but does not reflect the cash flow, because it is prepared using the accrual basis of accounting. Furthermore, expenses such as depreciation, amortization and provision for doubtful debts do not reflect cash outflows. 

There are two methods for calculating the cash from operating activities: direct method and Indirect method. The direct method takes the cash received from customers and subtracts the payments to creditors and other cash payments in order to arrive at the net cash flow from operating activities. These cash movements come from the firm’s operations. Operating cash flows includes cash sales, payments from customers for credit sales, payments to suppliers and paid employee wages. The indirect method starts with the net income from the profit and loss account and adds back all the non-cash expenditures to obtain the cash flow.

Cash flows from financing activities arise from issuing securities, such as equities and stock that result in the inflow of cash. Outflow of cash occurs due to the redemption of securities or repayment of debt. The shareholders equity and loan section should be thoroughly analyzed to construct the cash flow from financing activities accurately. Financing cash flows include the movement of cash associated with issuing and buying-back shares in the company, paying dividends to shareholders and borrowing or repaying loans

Investing cash flows are payments resulting from the use or sale of long-term assets. Movements of cash in this section include: 

• Payments for the purchase of property, plant and equipment (PP&E).
• The disposal (sale) of assets.
• Payments related to mergers and acquisitions.
• Dividends received from equity investments.