Back to: Financial Accounting
Hello everyone!
This week, we’re turning our focus to one of the most important financial reports after the Income Statement and Balance Sheet—the Cash Flow Statement.
It provides essential information about the cash inflows and outflows of a business, and it’s often considered just as important as the other two statements when evaluating a company’s financial health.
What is the Cash Flow Statement?
The Cash Flow Statement tracks the movement of cash into and out of a business over a specific period. Unlike the Income Statement, which uses accrual accounting, the Cash Flow Statement focuses purely on cash transactions—how cash is generated and spent.
A cash flow statement breaks down cash flows into three key sections:
Operating Activities:
This section shows cash flows from the core business activities, such as receiving payments from customers and paying suppliers and employees. It adjusts for changes in working capital (e.g., changes in receivables and payables) and non-cash expenses (like depreciation).
Investing Activities:
This part reflects cash flows related to buying and selling long-term assets, such as property, equipment, and investments. Cash spent on purchasing assets is recorded as an outflow, while cash received from selling assets is recorded as an inflow.
Financing Activities:
This section captures cash flows related to funding the business, such as issuing shares, borrowing money, or repaying loans. It also includes dividends paid to shareholders.
The formula looks like this:
Cash Flow from Operating Activities + Cash Flow from Investing Activities + Cash Flow from Financing Activities = Net Change in Cash
The Importance of the Cash Flow Statement
While the Income Statement gives you a sense of profitability, the Cash Flow Statement helps you understand how a company manages its cash. A company can be profitable on paper but still face liquidity issues if it doesn’t manage its cash properly. Conversely, a company may have strong cash flow but be unprofitable, which could be problematic in the long term.
Key points of interest in a Cash Flow Statement include:
Positive cash flow from operating activities indicates that the business is generating enough cash to cover its operations and grow.
Negative cash flow from operating activities may indicate underlying operational problems, even if the business appears profitable on paper.
Cash inflows from investing activities might signal that the business is selling assets, which could either be good (consolidating assets) or bad (struggling for liquidity).
Cash flow from financing activities shows how a company is financing its growth (through debt or equity).
Example of a Cash Flow Statement
Here’s a simplified example of a Cash Flow Statement for a fictional company, ABC Ltd:
ABC Ltd – Cash Flow Statement for the Year Ending 31 December
Section
Amount (N)
Cash Flow from Operating Activities
Net Income
20,000
Adjustments for:
Depreciation
5,000
Increase in Accounts Receivable
(3,000)
Increase in Accounts Payable
2,000
Net Cash from Operating Activities
24,000
Cash Flow from Investing Activities
Purchase of Equipment
(15,000)
Sale of Investment
8,000
Net Cash from Investing Activities
(7,000)
Cash Flow from Financing Activities
Proceeds from Loan
10,000
Dividends Paid
(2,000)
Net Cash from Financing Activities
8,000
Net Change in Cash
25,000
In this example, ABC Ltd has a net increase in cash of N25,000 over the year. It generated cash through its core operations, spent money on buying equipment, and received cash from financing activities such as taking out a loan.
The Direct vs. Indirect Method
There are two ways to prepare the cash flow from operating activities:
Direct Method: Shows actual cash receipts and payments. This method is less common because it requires more detailed information.
Indirect Method: Starts with net income and adjusts for changes in non-cash items (like depreciation) and working capital. This is the most commonly used method, especially for larger companies.