Overview of the Statement of Cash Flows; The statement of cash flows provides information about a business’s ability to generate cash. It is divided into three categories:
- Cash flow from operating activities
- Cash flow from investing activities
- Cash flow from financing activities
Summing together these three categories generates the company’s total change in cash for the period. Moreover, adding together the company’s beginning cash balance and the total change in cash should produce the ending cash balance for the period.
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As an in-house lawyer, you should be familiar with how to interpret the statement of cash flows. In particular, it is critical to understand what types of activities increase or decrease the company’s cash balance.
Cash Flow from Operating Activities
The first section of the statement of cash flows is the cash flow from operating activities. The top line item in this section is net income. This net income value must correspond to the net income value on the income statement.
After the net income line item, depreciation and amortization (D&A) is added. This is because D&A is a noncash expense. Other noncash expenses are also added as applicable.
Following this, a number of other adjustments are made for changes in operating assets and liabilities. This may include adjustments for changes in accounts receivable, changes in inventories, changes in prepaid expenses, changes in accounts payable, and changes in accrued expenses.
Cash Flow from Investing Activities
The second section of the statement of cash flows is the cash flow from investing activities. This section factors in the impact of acquisitions and sales of investments and long-term assets.
The line item that is most closely focused on in this section is capital expenditures, or capex. Capex represents the amount of money spent on acquiring long-term assets, which are commonly categorized on financial statements as property, plant and equipment (PP&E). Capital expenditures are considered a use of cash, and therefore would typically be listed as a negative number on the cash flow statement. However, the cash generated from the sale of a company’s PP&E would be recorded as a positive number.
Cash Flow from Financing Activities
The final section of the statement of cash flows is the cash flow from financing activities. This section provides information about changes in the company’s debt and equity positions. For example, the cash flow from financing activities section may reflect:
- Increases or decreases in short-term debt;
- Increases or decreases in long-term debt;
- Payments of common or preferred dividends;
- Issuance of common or preferred stock;
- Repurchase of common or preferred stock (e.g., treasury stock)
Increases in a company’s debt or equity are considered sources of cash and therefore would be listed as positive numbers on the statement of cash flows. Meanwhile, dividend payments, stock repurchases, or debt repayments are considered uses of cash and therefore would be recorded as negative values.
Statement of Cash Flows Example
A basic statement of cash flows is outlined below.
Cash from Operations
Change in Operating Assets and Liabilities
Total cash from operations
Cash from Investing
Sale of long-term assets
Total cash from investing
Cash from Financing
Change in debt
Change in equity
Total cash from financing
Total change in cash
Integrating the Three Key Financial Statements
The statement of cash flows is often considered a bridge between the two other main types of financial statements, namely the income statement and the balance sheet.
Every change on the balance sheet must correspond to a change somewhere on the cash flow statement. For example, an increase in assets on the balance sheet is reflected as a “use of cash” on the statement of cash flows, thus corresponding to a decrease in cash. Similarly, an increase in liabilities or shareholders’ equity on the balance sheet is reflected as a “source of cash” on the statement of cash flows, thus corresponding to an increase in cash.
The below illustrates basic formulations of the three financial statements and the key ways in which they are interconnected.
|Income Statement||Cash Flow Statement||Balance Sheet|
|Revenue||Cash from Operations||Assets|
|Less: COGS||Net income||Cash|
|Gross profit||D&A||Other current assets|
|Less: SG&A||Change in Operating Assets and Liabilities||PP&E and other long-term assets|
|Operating income||Total cash from operations||Total Assets|
|Less: Net interest expense|
|Earnings before taxes||Cash from Investing||Liabilities|
|Less: Taxes||Capex||Current liabilities|
|Net income||Sale of long-term assets||Debt and other long-term liabilities|
|Total cash from investing||Total Liabilities|
|Cash from Financing||Shareholders’ Equity|
|Change in debt||Retained earnings|
|Change in equity||Other equity|
|Total cash from financing||Total Shareholders’ Equity|
|Total change in cash|