The cash flow statement of a company gives an account of the cash movements into and out of a company during a year.
Although the income statement also shows incomes and expenses, some of them do not involve an exchange of cash. Incomes statements are based on accrual accounting. Meaning, they even consider incomes and expenses that are due, but where cash has not yet changed hands.
The income statement also has items like depreciation, where cash will never move into or out of the business. Such items are removed to show the pure cash position of the company. It also includes cash inflows and outflows that are recorded on the balance sheet.
How to read cash flow statement?
Companies present their statement of cash flows in one of two formats – direct and indirect. The indirect format is more common. Cash flow statements have three segments – Operating, Investing, and Financing. The idea is to see where the company generated most of its cash during the year and where it spent it.
Operating cash flows
In the indirect format, the Operating section of the cash flow statement starts with the company’s net income. This comes straight from the income statement. Net income includes non-operating items as well as non-cash items. These have to be removed to arrive at Operating cash flows.
Non-operating items are removed first, by subtracting non-operating incomes and adding non-operating expenses. This gives the company’s Earnings Before Tax (EBT) for the year. Next, non-cash incomes are subtracted from EBT and non-cash expenses (such as depreciation) are added to it.
The next set of adjustments remove non-cash items that come from the balance sheet. Increases in current assets (other than cash) and decreases in current liabilities represent an increase in non-cash working capital. As such, they are subtracted.
Similarly, increases in current liabilities and decreases in current assets represent a decrease in non-cash working capital, and are added back. The cash flow statement illustration below summarizes these adjustments.
Statement of Cash Flow of ABC Limited for the Financial Year Ended 31/12/2017
Net Income (as on the Income Statement)
+ Non-operating Expenses
– Non-operating Incomes
+ Income Tax
Earnings Before Tax (EBT)
+ Non-cash Expenses
– Non-cash Incomes
+ Decrease in Working Capital
– Increase in Working Capital
Cash Flow from Operating Activities
+ Cash Generated from the Sales of Fixed Assets and Securities
– Cash Spent on Purchase of Fixed Assets and Securities
+ Dividend and Interest Received from Investment in Securities
Cash Flow from Investing Activities
+ Cash Received from Issuance of Fresh Equity / Debt
– Cash Paid for Equity Repurchase / Repayment of Debt
– Interest / Dividend Paid
Cash Flow from Financing Activities
+ Opening Balance of Cash and Cash Equivalents
Closing Balance of Cash (as on the Balance Sheet)
Investing cash flows
In this section, adjustments are made for cash flows related to investments in fixed assets (such as land and buildings) and financial assets (such as securities of other companies). The Investing section includes cash flows from:
Sale and purchase of fixed assets
Sale and purchase of stake in other companies
Sale and purchase of financial instruments like shares, bonds, and mutual funds
Dividends and interest received from investments in financial instruments
The sale of any of the assets listed above and the receipt of interest and dividends are cash inflows. They are added when calculating investing cash flows. All purchases listed above involve cash outflow and are subtracted when calculating Investing cash flows.
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