The cash flow statement or statement of cash flows is an essential financial accounting tool. It is used along with income statements and balance sheets to analyse the financial position of an enterprise. However, it differs from both because it does not record the future outgoing and incoming cash under the credit front.
It encapsulates the cash and cash equivalents a company receives and spends. The cash that enters as income for the company is called cash inflow, and the cash that leaves the company as an expense is known as cash outflow.
Besides that, it evaluates the cash management system of an enterprise. In other words, it assesses how well an enterprise can generate capital to fund its operating costs and pay off its debt obligations.
Key Takeaways
- A cash flow statement is a financial document showing the cash inflow and outflow within a company.
- It helps evaluate the company’s liquidity, cash position, and cash management efficiency.
- The cash flow statement consists of operating, investing, and financing activities.
Components of a Cash Flow Statement
A Cash Flow Statement primarily comprises the following:
1. Cash from operating activities
This constitutes the first section of the cash flow statement and includes the varied sources of cash generated from a business enterprise’s activities.
These operations may include interest payments, income tax payments, cash received from the sale of products and services, expenditures on production-related goods and services, salaries of employees, rents and other expenses related to company operations.
If the enterprise is an investing company, the cash flow statement may also include equity or debt instruments and the sale of loans.
2. Cash from investing activities
This constitutes the second section of the cash flow statement and records the various sources of cash generated from a business’s investments. These sources include investment gains, losses, and cash spent on plant, property, and equipment.
The accountants look for this section to find out if there is any change in capital expenditures. If capital expenditure increases, it implies a negative cash flow; if the cash flow is positive, the company is generating a lot of cash.
Cash from financing activities
This constitutes the last section of a cash flow statement and comprises the varied sources of the company’s cash for financing activities. These activities include payment of dividends to shareholders, repayment of loans and payments for share repurchase.
As the cash flow statement observes the cash generated by a company in the three ways mentioned above, it is considered the most intuitive financial statement. The aggregate of these three sections of the cash flow statement is called the net cash flow. Besides that, an analysis of these three segments allows the investors, lenders and company directors to determine the value of an enterprise’s stocks or the company as a whole.
Advantages of Cash Flow Statement
Some of the significant advantages of a cash flow statement include the following:
- It helps the company to keep track of its liquidity condition.
- It shows a company’s capacity to pay off its bills.
- It enables a company to prepare its future estimates based on its cash inflows and outflows.
- It helps a company get loans and attract investments as lenders and investors can evaluate its stocks from its components.
- A proper cash flow statement allows judicious management of cash.
Disadvantages of Cash Flow Statement
Despite being an intuitive financial statement, the statement of cash flows is not without its share of limitations:
- The cash flow statement does not reflect a company’s net income as it only records cash transactions, not non-cash items.
- The financial status of a company cannot be assessed by the cash flow statement alone. It needs to be supported by the income statement and balance sheet.
- Preparing a cash flow statement is based on historical or book value. Consequently, it does not give an estimation of future cash flows.
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- https://www.emerald.com/insight/content/doi/10.1108/03074351311323455/full/html
Last Updated : 11 June, 2023
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Chara Yadav holds MBA in Finance. Her goal is to simplify finance-related topics. She has worked in finance for about 25 years. She has held multiple finance and banking classes for business schools and communities. Read more at her bio page.
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