14.6 The Statement of Cash Flows

The Statement of Cash Flows

Inflows and Outflows

A company can be profitable on paper and still run out of cash. The Statement of Cash Flows exists to prevent that surprise. It tracks every dollar of cash coming in (inflows) and going out (outflows) over a specific period, showing the actual movement of money rather than just revenue earned or expenses recorded.

The statement is divided into three sections: operating activities, investing activities, and financing activities. Each section produces its own net cash figure (positive or negative), and those three figures are added together to find the overall change in cash for the period.

To find the ending cash balance, you follow this simple formula:

This ending balance should match the cash figure reported on the balance sheet, which is one way accountants verify that everything ties together.

Operating, Investing, and Financing Activities

These three categories capture different types of cash movement. Understanding what belongs in each one is the core skill for reading this statement.

Operating Activities cover cash flows from the company's day-to-day business:

• Cash received from customers
• Cash paid to suppliers and employees
• Income tax payments
• Adjustments for non-cash items like depreciation and amortization (these reduce net income on the income statement but don't involve actual cash leaving the company, so they get added back)

Operating activities are the most closely watched section because they show whether the core business itself generates enough cash to sustain operations.

Investing Activities cover cash flows tied to long-term assets:

• Purchasing or selling property, plant, and equipment
• Buying or selling investment securities
• Making loans to other entities or collecting on those loans

A company spending heavily on new equipment will show negative investing cash flow. That's not necessarily bad; it often signals growth.

Financing Activities cover cash flows between the company and its owners or creditors:

• Issuing stock or bonds (cash inflow)
• Repaying debt (cash outflow)
• Paying dividends to shareholders (cash outflow)

This section reveals how a company funds itself and how much cash it returns to investors.

Impact of Account Changes

Changes in certain balance sheet accounts directly affect the cash flow statement. These are the three most common ones to understand:

Accounts Receivable:

1. An increase means the company made more sales on credit that haven't been collected yet. Cash flow from operations goes down because revenue was recorded but cash wasn't received.
2. A decrease means the company collected more cash than it billed in new credit sales. Cash flow from operations improves.

Inventory:

1. An increase means the company bought more goods than it sold, tying up cash in unsold products. This decreases operating cash flow.
2. A decrease means the company sold through existing stock without replacing all of it, freeing up cash and improving operating cash flow.

Debt:

1. An increase (taking out a new loan or issuing bonds) brings in cash under financing activities. Keep in mind this also creates future outflows for interest payments and principal repayment.
2. A decrease (repaying a loan) is a cash outflow under financing activities, reducing the company's cash position but also reducing its obligations.

The pattern to remember: increases in assets (like receivables and inventory) use cash, while increases in liabilities (like debt) provide cash. Decreases work in the opposite direction.