The Cash Flow Statement is an analysis of sources of cash that flowed into and out of the business for the accounting period. The information is grouped by functional department, because Cash can be freed up from anywhere (such as getting customers to pay faster, or paying suppliers more slowly), not just from Sales or the Finance Department.
The Cash Flow Statement is also known as the Statement of Cash Flows. It has also been called the Sources and Uses of Funds.
Financial Statements
There are three main pillars of financial reporting. We’ve already discussed Income Statements and Balance Sheets. But what is a Cash Flow Statement and what does it show?
The broad purpose of a Cash Flow Statement is to show where cash in your business is being freed up and where it’s being tied up.
It examines a company’s sources and uses of cash by looking at the change in position from the balance sheet at the end of the previous year to the balance sheet at the end of the current year.
The Structure of the Cash Flow Statement
The report begins with the net profit for the year, shown at the bottom of the Income Statement. It then adds back non-cash items that were subtracted from the Income Statement; i.e. the depreciation of fixed assets.
While depreciation is considered an expense, it is not a cash expense, and this report is only concerned with cash. In the case of depreciation, you are writing off the value of an asset that has already been paid for. No new cash is going out of the business, so you need to reverse that expense on the Income Statement.
Once the depreciation value is added back to the Net Income, a subtotal is generated: Cash Flow.
Next, you evaluate the changes in non-cash working capital between your current and previous balance sheets. This includes non-cash current assets (inventories, receivables) and current liabilities (payables).
- All other things being equal, more Receivables means that customers are not giving you cash quickly, so you have less cash. Similarly, if you pay Cash for Inventory then more Inventories means you have less cash – but if you do not paying your suppliers quickly, you will have more Payables and more cash.
The new subtotal is called Operating Cash Flow.
Next, look at the changes in long-term investments like PP&E (Property, Plant & Equipment).
- If you buy equipment, you have less Cash; if you sell it, you have more cash.
The new subtotal is called Free Cash Flow.
Finally, look at changes in financing, which can be based on either debt or equity.
- You have more cash by taking on more debt or by issuing more shares. You have less cash if you pay off existing debt, pay dividends, or if you buy back shares.
The new total is Change in Cash. This is the difference in cash between now and the previous reporting period.
Good And Bad Cash Flow
Perhaps a simpler way to look at freed-up vs. tied-up cash is to categorize decisions as “good” or “bad” for your cash flow.
This is how a Cash Flow Statement works. You can reference it to determine, from one year to the next, whether you have gained or used up cash.Cash drives the business.
Graphic lists examples of good cash flow e.g. receiving payments quickly (cash comes in) and bad cash flow e.g. bloated inventories (cash goes out).
The heart of business success is cash. A profitable business with inadequate cash flow will go bankrupt – it happens all the time. The Cash Flow Statement analyzes that crucial aspect of the business: where the money came from and where it went.
Over time, the statement indicates whether or not the operation is healthy and sustainable. For example, you can’t keep giving your customers longer and longer to pay without running out of money. You can’t keep funding a loss-making business by borrowing–the bank will eventually stop lending you money.
Profit vs. Cash
Analyzing cash flow has important implications for major business decisions. It’s possible to be profitable and to expand into a profitable opportunity, and simultaneously burden the business with disproportionate cash outflow obligations.
In this scenario, if it takes time to ramp up production, or if money from customers isn’t coming in fast enough or if there are huge debts to pay for new equipment and stocks of inventory, you may simply run out of cash… and go bankrupt.
“You can go bankrupt even though you’re running an operation that is profitable on paper and would have paid for itself eventually.”
Profit is a long-term view of what’s healthy in a business. Cash flow represents the immediate financial reality.
“Cash Flow is what helps you survive day to day.“
Every business must monitor the relationship between profit and cash flow, especially as it pertains to the sales team. One of the ‘sweeteners’ that helps salespeople close deals is if they can tell their customers they don’t have to pay for 90 days, or six months, or even a year.
- As far as the salesperson is concerned, their job is to make a profitable sale. They’re not always measured by the timing of the cash flow.
- It helps the customer too, because the cash flow out of the customer is delayed by 90 days (or six months or a full year!).
But the seller’s company needs the cash from the sale in order to keep functioning, so that profitable sale might actually harm the company.
Case Study in Cash Flow
In the early 90s, Marvel experienced a sales boom due to the collectibles market. However, their reliance on comic book distributors and retailers who took too long to pay their invoices created severe cash flow problems. The delays in receiving payments from these distributors meant Marvel struggled to cover its operating costs.
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Marvel Comics declared bankruptcy in 1996 because their customers took too long to pay. |
The bubble soon burst, and coupled with debt from acquisitions like trading card company Fleer, the company filed for bankruptcy in 1996 despite high sales volumes, due to these cash flow issues.
Conclusion
Typically, investors are the people most likely to request to see a Cash Flow Statement. They’re analyzing sustainability or looking for excess cash being generated that can be paid out as dividends.
But the fact that this report is used by only a select group does not take away from the significance of the report. The Cash Flow Statement offers an insightful look into the financial sources and uses of funds within the company, and into the likelihood that the business will succeed in the future.
📈Up Your Business Game: Cash Flow Statement AnalysisObjective: To enhance your understanding of cash flow management and develop your ability to analyze real-world financial statements. |
Instructions
- Select a Company for analysis (your company, a customer, a competitor, or a company you are considering investing in). This will show financial data for the reporting year and 1 or 2 years previous.
- Locate the Cash Flow Statement: It may have a different name – Statement of Cash Flows or Statement of Changes in Cash.
- Analyze the Cash Flow Statement over the two most recent years. Compare the 4 sets of changes:
- Changes in Cash from Operations,
- Changes in non-cash working capital,
- Changes in long-term investments (e.g. PP&E)
- Changes in financing activities
Identify any significant changes or surprises in the cash flow patterns.
- Identify Key Factors:
- Consider the potential reasons behind these changes. What events, decisions, or external factors might have caused these variations in cash flow?
- Look for any one-time events or unusual items that impacted the cash flow.
- You may find answers in the Notes to the Financial Statements.
- What is Your Analysis?
- Did the cash flow from operating activities increase or decrease?
- Were there major investments or divestments?
- Did the company take on new debt or repay debt significantly?
What do these cash flow changes suggest about the company’s financial health and strategy?
This Cash Flow Statement exercise aims to build your business acumen and critical thinking skills by engaging with real-world financial data. Happy analyzing!