Cash Flow

Statement:
Explanation
and
Example
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The cash flow statement, a
crucial financial document
submitted by corporations
alongside the income
statement and balance
sheet, is frequently
neglected by investors and
analysts, despite its vital
significance.

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The cash flow statement
reveals the company's cash
management efficiency by
outlining the inflow and
outflow of cash, offering
insights into its financial
operations beyond the
income statement and
balance sheet.

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 Cash flows are
not equal to
the net profit
earned from
the business

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Companies typically
adopt accrual
accounting, where
revenue is recognized
when earned and
expenses when incurred,
differing from cash
accounting methods.

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Non-cash income/expenses
in the income statement
contribute to the disparity
between net profit and cash
flows, underscoring the
need to examine the cash
flow statement for an
accurate understanding of
the business's cash position.

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 Types of
cash flows

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A Cash flow statement
has 3 parts;

Cash flows from operating

activities (CFO)
Cash flows from investing
activities (CFI)
Cash flows from financing
activities (CFF)

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Let us understand each
of them one by one.

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 Cash flow from
operating
activities/
Cash flow from
operations

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The operating activities section
of the cash flow statement is
pivotal, detailing the
company's cash generation
from core operations,
encompassing daily activities
such as sales, expenses,
employee salaries, and taxes,
crucially illustrating cash
sources and uses over a
specific period.

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Cash flow from operations
can be prepared by two
methods:

Direct Method
Indirect Method

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Both the methods give
the same result (ie; cash
flow from operations)

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Direct method includes
Cash sales
Add: Payment received
from customers
Less: Payment made to
vendors
Less: Payment made for
expenses, taxes etc.

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This is more intuitive
compared to the indirect
method. However, it
takes more time to
prepare a cash flow
from operations
statement using Direct
Method.

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Net Income
Add: Depreciation and
Amortization
Add/ Less: Interest paid/
Interest received (as these
are not related to ongoing
operating activities)
Add/Less: Changes in
Working capital (Increase in
working capital is a cash
outflow and vice versa)

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Preparing CFO by this
method easy
compared to the Direct
Method. Companies
usually prepare this
statement using
indirect method.

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 Cash flow
from
investing
activities

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Cash flow from investing
activities reflects a company's
expenditures on future growth
through investments in
assets, acquisitions, or
securities, typically resulting
in negative cash outflows;
exceptions occur when assets
or investments are sold,
generating positive cash flow.

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 Cash flow
from
financing
activities
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This section encapsulates
capital-related transactions,
encompassing capital raising
through share issuance or
debt financing, along with
capital repayment involving
debt settlement, share
repurchases, interest
payments to debt holders,
and dividends to shareholders.

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At the bottom of the cash flow
statement, we have the cash
reconciliation. It shows
opening cash balance and the
ending cash. The difference
between the two should be
equal to the net cash inflow or
outflow from the three cash
flow activities described
above.

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In other words,

Cash balance at the

beginning of the period

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+/- Cash flows from operating
activities
+/- Cash flows from investing
activities
+/- Cash flows from financing
activities
= Cash balance at the end of
the period

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Typically, as a Financial
Analyst, we need to
periodically assess the cash
flows statements of a
company through financial
modelling in Excel exercise. It
will require detailed
assessment of financial
analytics of a company both
for historical as well as future
years.

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Let us look at an
example. Here we have
a cash flow statement
of “Alphabet Inc.”

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Cash flow from Operating
activities, Cash flow from
Investing Activities and
Cash flow from Financing
activities have been
highlighted below.

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Now let us review each
of the activities one by
one.

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 Cash flow
from
operating
activities
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The cash flow from operating
activities, prepared using the
indirect method, starts with net
income and adjusts for non-
cash expenses like depreciation,
amortization, and stock-based
compensation, deducts
gain/loss on debt/equity
securities, and accounts for
changes in working capital;

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For instance, increased
accounts receivable is a
negative since it didn't convert
to cash, while increased
accounts payable and
accrued expenses are
positives as they didn't lead to
cash outflows.

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This statement shows that
“Alphabet Inc.” has
generated $54,520 million
cash during the financial
year 2019.

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This statement shows that
“Alphabet Inc.” has
generated $54,520 million
cash during the financial
year 2019.

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 Cash flow
from
investing
activities
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Cash flow from investing
activities includes capex
investment for future
growth, Purchase and
sale of investments and
cash outflow on
acquisitions.

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 Cash flow
from
financing
activities
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This includes payment to
shareholders in the form of
share repurchases, stock
options and issuance and
repayment of borrowings.

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At the end of the cash flow
statement, we have the Cash
reconciliation.

Net increase/decrease in cash

and cash equivalents is the
sum of all the three cash flow
activities plus effect of foreign
exchange rate changes.

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It shows that cash balance
for Alphabet Inc. increased
by $1,797 million in 2019.

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Below it we have the cash and cash
equivalents at the beginning and end
of the period.

Ending cash balance for Alphabet is

$18,498 million which should be
equal to what is reported in the
closing balance sheet for the period.

Here is the screen shot from the cash

flow statement and balance sheet.

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Skillfine.com
 Ashish Agarwal

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