5.5 The Statement of Cash Flows
3 min read•june 18, 2024
The Statement of Cash Flows is a vital financial report that shows a company's cash inflows and outflows. It's split into three sections: operating, investing, and . This breakdown helps investors and managers understand where money is coming from and going.
By analyzing cash flows, you can gauge a company's financial health and flexibility. Key metrics like Operating Cash Flow and Free Cash Flow reveal if a business can sustain itself, grow, and handle unexpected challenges. Understanding cash flows is crucial for making smart financial decisions.
The Statement of Cash Flows
Purpose of cash flow statement
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- Provides information about a company's cash inflows and outflows during a specific period (quarterly or annually)
- Helps stakeholders assess the company's measures its ability to meet short-term obligations ()
- Demonstrates the company's evaluates its ability to meet long-term debt obligations ()
- Showcases the company's indicates its ability to adapt to changing economic conditions ()
Structure of cash flow statement
- Divided into three main sections: , investing activities, and
- section reports cash flows related to the company's core business operations ( of goods or services)
- Investing activities section presents cash flows related to the acquisition and disposal of long-term assets ()
- Financing activities section displays cash flows related to the company's financing activities, such as issuing or repaying debt and equity ( or )
Types of cash flow activities
- Operating activities
- Include cash inflows and outflows from the company's primary
- Cash inflows examples: cash received from customers (product sales), earned (investments)
- Cash outflows examples: cash paid to suppliers (), employees (), (loans), taxes paid ()
- Adjustments to net income: non-cash expenses like (equipment wear and tear), (intangible assets), and changes in ( and )
- Investing activities
- Include cash flows related to the purchase and sale of long-term assets
- Cash outflows examples: purchase of (factories), acquisition of other companies (), purchase of long-term investments ( or bonds)
- Cash inflows examples: proceeds from the sale of long-term investments (stocks or bonds), sale of property, plant, and equipment (land or buildings)
- Financing activities
- Include cash flows related to the company's financing activities
- Cash inflows examples: issuing long-term debt (bonds), issuing stock ( or )
- Cash outflows examples: repaying long-term debt (loan payments), repurchasing stock (), paying to shareholders (quarterly or annual distributions)
Key cash flow metrics
-
- Represents the cash generated from a company's core business operations
- Calculation:
- A positive OCF indicates the company is generating sufficient cash from its operations to sustain and grow its business (expanding production)
-
- Represents the cash available to the company after accounting for
- Calculation:
- A positive FCF indicates the company has excess cash available for discretionary purposes, such as paying (to shareholders), repurchasing shares (stock buybacks), or investing in growth opportunities ()
- Interpreting cash flow metrics
- Higher OCF and FCF generally indicate a healthier financial position and greater financial flexibility (weathering economic downturns)
- Comparing a company's cash flow metrics to its industry peers provides insights into its relative financial performance and liquidity (benchmarking against competitors)
- Analyzing trends in cash flow metrics over time helps assess the company's ability to generate and sustain cash flows (long-term financial stability)
Accounting methods and additional considerations
- vs.
- Accrual accounting records revenues and expenses when they are earned or incurred, regardless of when cash is received or paid
- accounting records transactions only when cash is received or paid
- Direct and indirect methods for preparing the statement of cash flows
- reports major classes of operating cash receipts and payments
- starts with net income and adjusts for and changes in working capital
- are short-term, highly liquid investments that are readily convertible to known amounts of cash
- Non-cash transactions, such as equipment purchases through lease agreements, are typically disclosed in footnotes to the
Key Terms to Review (56)
Accounts Payable: Accounts payable refers to the short-term debt obligations a company owes to its suppliers or vendors for goods and services received. It represents the amount a company owes to its creditors and is a crucial component of a company's working capital and cash flow management.
Accounts Receivable: Accounts receivable refers to the money owed to a company by its customers for goods or services provided on credit. It represents the outstanding balance that customers have yet to pay for their purchases, and it is considered a current asset on the company's balance sheet.
Accounts receivable aging schedule: An accounts receivable aging schedule is a report that categorizes a company's accounts receivable according to the length of time an invoice has been outstanding. It helps businesses identify overdue payments and manage credit risk.
Accrual Accounting: Accrual accounting is a method of accounting that records revenues and expenses when they are earned or incurred, regardless of when the actual cash payment is received or made. This contrasts with cash-basis accounting, which records transactions only when cash is exchanged.
Amortization: Amortization is the process of gradually writing off the initial cost of an asset over a set period. It is often used in accounting to allocate the cost of intangible assets such as patents or goodwill.
Amortization: Amortization is the process of gradually reducing a debt or expense over a period of time through regular payments or allocations. It is a key concept in finance that is relevant to various financial statements and time value of money calculations.
Apple, Inc.: Apple, Inc. is a multinational technology company known for its innovative products such as the iPhone, MacBook, and Apple Watch. It is also one of the largest publicly traded companies by market capitalization.
Bank Loans: Bank loans refer to the credit facilities extended by financial institutions, primarily banks, to individuals, businesses, or organizations. These loans provide borrowers with access to funds for various purposes, such as financing investments, funding operations, or meeting personal financial needs.
Bonds: Bonds are debt securities that represent a loan made by an investor to a borrower, typically a government or corporation. They are a type of fixed-income financial instrument that provide the holder with a contractual right to receive a series of payments over time, including the repayment of the principal amount at maturity. Bonds are central to the understanding of financial instruments, cash flow analysis, and the timing of cash flows.
Capital Expenditures: Capital expenditures (CapEx) refer to the funds used by a company to acquire, upgrade, or maintain physical assets such as property, buildings, equipment, or technology. These investments are made with the expectation of generating future benefits and are critical in the context of financial statements, cash flow analysis, and valuation models.
Cash basis: Cash basis is an accounting method where revenues and expenses are recorded only when cash is received or paid. It contrasts with the accrual basis, which records income and expenses when they are incurred.
Cash Basis Accounting: Cash basis accounting is a method of recording financial transactions where revenues and expenses are recognized when cash is received or paid, rather than when the transaction occurs. This contrasts with the accrual basis of accounting, which records revenues when earned and expenses when incurred, regardless of the timing of cash flow.
Cash Equivalents: Cash equivalents are highly liquid, short-term investments that can be readily converted into known amounts of cash and have a maturity of three months or less from the date of acquisition. They are considered a part of a company's cash and cash management strategy, providing a way to earn a modest return on excess cash holdings.
Cash Flow Statement: The cash flow statement is a financial statement that reports the inflows and outflows of cash and cash equivalents over a specific period of time. It provides a comprehensive view of a company's liquidity and ability to generate cash from its operations, investing, and financing activities. The cash flow statement is a crucial component in understanding a company's overall financial health and performance.
Convertible bonds: Convertible bonds are a type of bond that can be converted into a predetermined number of shares of the issuing company’s stock. They offer the benefits of fixed-income securities with the potential for equity appreciation.
Days’ sales: Days’ sales, also known as Days Sales Outstanding (DSO), measures the average number of days it takes a company to collect payment after a sale. It is an indicator of the efficiency of a company’s accounts receivable management.
Days’ sales in inventory: Days' sales in inventory measures how many days it takes for a company to sell its entire inventory. It is an indicator of the efficiency of a company's inventory management and sales performance.
Depreciation: Depreciation is an accounting method used to allocate the cost of a tangible asset over its useful life. It represents the gradual decline in an asset's value due to wear and tear, age, and obsolescence. Depreciation is a critical concept in understanding how a company recognizes sales, expenses, and the relationship between the balance sheet and income statement.
Direct method: The direct method is a way of preparing the cash flow statement by directly listing all major operating cash receipts and payments. It provides a detailed account of cash inflows and outflows from operating activities, giving a clear view of how cash is generated and used in day-to-day business operations.
Direct Method: The direct method is a technique used in the preparation of the statement of cash flows, which directly reports the major classes of gross cash receipts and gross cash payments. This approach provides a clear and transparent view of the sources and uses of a company's cash during the accounting period.
Dividends: Dividends are portions of a company's earnings distributed to shareholders, usually in the form of cash or additional shares. They provide an incentive for investors and represent a share of corporate profits.
Dividends: Dividends refer to the distribution of a portion of a company's profits to its shareholders. They represent the cash or stock payments made by a corporation to its stockholders as a return on their investment in the company's equity.
Equipment Purchases: Equipment purchases refer to the acquisition of tangible, long-lived assets that are used in a business's operations. These purchases are a key component of the investing activities section of the statement of cash flows, as they represent the outflow of cash to obtain the necessary equipment and machinery to support the company's operations.
FASB (Financial Accounting Standards Board): The Financial Accounting Standards Board (FASB) is an independent organization responsible for establishing and improving financial accounting and reporting standards in the United States. These standards are known as Generally Accepted Accounting Principles (GAAP).
Financial Flexibility: Financial flexibility refers to a company's ability to adapt and respond to changing financial circumstances, allowing it to access additional funds or reallocate resources as needed. This concept is crucial in the context of cash flow management, capital structure decisions, and a firm's overall financial resilience.
Financing activities: Financing activities are transactions and events whereby a business raises or repays capital. These activities include issuing stock, borrowing funds, and repaying debts.
Financing Activities: Financing activities refer to the cash inflows and outflows related to a company's capital structure, including the issuance and repayment of debt, the issuance of equity, and the payment of dividends. These activities are crucial in understanding a company's financial position and its ability to fund its operations and growth.
Free Cash Flow (FCF): Free cash flow (FCF) is the amount of cash a company generates after accounting for capital expenditures and other cash needs. It represents the cash available for distribution to shareholders or for reinvestment in the business, and is a key metric used in stock valuation and financial analysis.
Great Recession: The Great Recession was a severe global economic downturn that occurred from late 2007 through mid-2009, primarily triggered by the collapse of the housing market in the United States. It led to widespread financial instability, high unemployment rates, and significant declines in consumer wealth.
Gross working capital: Gross working capital is the total value of a company's current assets, which are assets that are expected to be converted into cash within one year. It includes cash, accounts receivable, inventory, and other short-term assets.
Income Taxes: Income taxes are a type of tax levied on the monetary income and gains of individuals and businesses. They are a key component of a country's tax system and a primary source of revenue for governments to fund public services and programs.
Indirect method: The indirect method is a way of preparing the statement of cash flows by starting with net income and adjusting for changes in balance sheet accounts to calculate operating cash flow. It contrasts with the direct method, which lists actual cash receipts and payments during the period.
Interest Expense: Interest expense is the cost incurred by an individual or organization for borrowing money. It represents the payments made to lenders or creditors for the use of their capital, and is a critical component in understanding a company's financial performance and solvency.
Interest Income: Interest income refers to the revenue generated from the investment of funds, such as loans, bonds, or other interest-bearing assets. It is a crucial component in the analysis of a company's financial performance and cash flow, particularly in the context of the Statement of Cash Flows.
Inventory: Inventory refers to the goods and materials a business holds in stock, including raw materials, work-in-progress, and finished goods. It is a critical component of a company's assets and plays a vital role in the financial management and operations of an organization.
Inventory Purchases: Inventory purchases refer to the acquisition of goods or materials that a business intends to sell or use in the production of its products. These purchases are a crucial component of the cash flow statement, specifically within the context of the Statement of Cash Flows.
IPO: An IPO, or Initial Public Offering, is the process by which a private company sells its shares to the public for the first time, transitioning from a private to a publicly-traded company. This event allows the company to raise capital by selling equity shares on a stock exchange, providing access to public markets and increased liquidity for investors.
Liquidity: Liquidity refers to the ease and speed with which an asset can be converted into cash without significant loss in value. It is a crucial concept in finance that encompasses the ability of individuals, businesses, and markets to readily access and transact with available funds or assets.
Mergers: A merger is a combination of two or more companies into a single entity, where one company absorbs the other(s) and the acquired company's stock is exchanged for or converted into the acquiring company's stock. Mergers are a strategic business decision that can lead to increased market share, economies of scale, and synergies between the combined entities.
Non-Cash Transactions: Non-cash transactions are business activities that do not involve the exchange of cash, but rather the exchange of other assets or the assumption of liabilities. These transactions are important in the context of the Statement of Cash Flows, as they need to be identified and accounted for separately from cash-based activities.
Noncash expenses: Noncash expenses are costs reported on the income statement that do not involve an actual cash outflow during the period. Examples include depreciation, amortization, and stock-based compensation.
Operating activities: Operating activities refer to the core business functions and processes that generate revenue and incur expenses. These activities are crucial for maintaining daily operations and include tasks like sales, production, marketing, and administration.
Operating Activities: Operating activities refer to the day-to-day business operations that generate a company's primary source of revenue. These activities involve the production, sale, and delivery of a company's goods or services, as well as the collection of cash from customers and the payment of cash to suppliers and employees.
Operating Cash Flow (OCF): Operating cash flow (OCF) is a measure of the amount of cash generated by a company's normal business operations, excluding the effects of financing and investing activities. It represents the cash a company generates from the revenues it brings in, providing a snapshot of the company's financial health and ability to fund its operations.
Property, Plant, and Equipment: Property, Plant, and Equipment (PP&E) refers to the tangible long-term assets a company owns and uses in its operations to generate revenue. These assets have a physical form and are not intended for sale, but rather for the company's own use over an extended period of time.
Recession: A recession is a significant decline in economic activity that lasts for a prolonged period, typically characterized by a drop in gross domestic product (GDP), increased unemployment, and decreased consumer spending and business investment. It is a cyclical phase within the broader business cycle that follows a period of economic expansion.
Research and Development: Research and development (R&D) refers to the activities that companies and organizations undertake to innovate and introduce new products or services. It involves the systematic investigation, experimentation, and exploration of new ideas, technologies, and processes to advance scientific knowledge and create practical applications.
Revenue-Generating Activities: Revenue-generating activities refer to the various business operations and transactions that directly contribute to a company's total revenue or income. These activities are the primary sources of a company's financial inflows and are essential for sustaining and growing the business.
Salaries: Salaries refer to the fixed, regular monetary payments made by an employer to an employee in exchange for their work and services. Salaries are a crucial component of the Statement of Cash Flows, as they represent a significant cash outflow for a business.
Sales: Sales refers to the revenue generated by a business through the exchange of goods or services for monetary compensation. It is a critical component of a company's financial performance and is closely tied to its profitability and cash flow.
Secondary Offering: A secondary offering is the sale of additional stock shares by a company that has already gone public. It allows existing shareholders, such as company founders or venture capitalists, to sell a portion of their ownership stake in the company to the public.
Share Buybacks: Share buybacks, also known as stock repurchases, refer to the process where a company buys back its own shares from the marketplace. This reduces the number of outstanding shares, which can impact various financial metrics and the company's capital structure.
Solvency: Solvency refers to a company's ability to meet its long-term financial obligations and debt commitments. It is a measure of a firm's financial health and its capacity to continue operating and growing its business without the risk of defaulting on its debts.
Stock Issuance: Stock issuance refers to the process of a company creating and selling new shares of its stock to raise capital. It is a crucial component of the Statement of Cash Flows, as it represents one of the primary ways a company can generate cash to fund its operations, investments, and other activities.
Stocks: Stocks, also known as equities, represent ownership shares in a publicly traded company. They are financial instruments that allow investors to participate in the growth and profitability of a business, with the potential for capital appreciation and dividend income.
Working Capital: Working capital refers to the difference between a company's current assets and current liabilities, representing the liquid resources available to fund day-to-day business operations. It is a crucial metric that reflects a company's short-term financial health and liquidity position, with implications across various financial statements and analysis techniques.