The Statement of Cash Flows (also referred to as the cash flow statement) is one of the three key financial statements that reports the cash generated and spent during a specific period of time (i.e., a month, quarter, or year). The statement of cash flows acts as a bridge between the income statement and balance sheet by showing how money moved in and out of the business.
Three Sections of the Statement of Cash Flows:
- Operating Activities: The principal revenue-generating activities of an organization and other activities that are not investing or financing; any cash flows from current assets and current liabilities
- Investing Activities: Any cash flows from the acquisition and disposal of long-term assets and other investments not included in cash equivalents
- Financing Activities: Any cash flows that result in changes in the size and composition of the contributed equity capital or borrowings of the entity (i.e., bonds, stock, dividends)
Cash Flow: Inflows and outflows of cash and cash equivalents (learn more in CFI’s Ultimate Cash Flow Guide)
Cash Balance: Cash on hand and demand deposits (cash balance on the balance sheet)
Cash Equivalents: Cash equivalents include cash held as bank deposits, short-term investments, and any very easily cash-convertible assets – includes overdrafts and cash equivalents with short-term maturities (less than three months).
Cash Flow Classifications
- Operating Cash Flow
Operating activities are the principal revenue-producing activities of the entity. Cash Flow from Operations typically include the cash flows associated with sales, purchases, and other expenses.
The company’s chief finance officer (CFO) chooses between the direct and indirect presentation of operating cash flow:
Direct Presentation: Operating cash flows are presented as a list of cash flows; cash in from sales, cash out for capital expenditures, etc. Simple but rarely used method, as the indirect presentation is more common.
Indirect Presentation: Operating cash flows are presented as a reconciliation from profit to cash flow:
Impairment expense I
Change in working capital ΔWC
Change in provisions ΔP
Interest Tax (I)
Operating cash flow OCF
The items in the cash flow statement are not all actual cash flows, but “reasons why cash flow is different from profit.”
Depreciation expense reduces profit but does not impact cash flow (it is a non-cash expense). Hence, it is added back. Similarly, if the starting point profit is above interest and tax in the income statement, then interest and tax cash flows will need to be deducted if they are to be treated as operating cash flows.
There is no specific guidance on which the profit amount should be used in the reconciliation. Different companies use operating profit, profit before tax, profit after tax, or net income. Clearly, the exact starting point for the reconciliation will determine the exact adjustments made to get down to an operating cash flow number.
- Investing Cash Flow
Cash Flow from Investing Activities includes the acquisition and disposal of non-current assets and other investments not included in cash equivalents. Investing cash flows typically include the cash flows associated with buying or selling property, plant, and equipment (PP&E), other non-current assets, and other financial assets.
Cash spent on purchasing PP&E is called capital expenditures (or CapEx for short).
- Financing Cash Flow
Cash Flow from Financing Activities are activities that result in changes in the size and composition of the equity capital or borrowings of the entity. Financing cash flows typically include cash flows associated with borrowing and repaying bank loans, and issuing and buying back shares. The payment of a dividend is also treated as a financing cash flow.
Interest and Cash Flow
Under IFRS, there are two ways of presenting interest expense in the cash flow statement. Many companies present both the interest received and interest paid as operating cash flows. Others treat interest received as investing cash flow and interest paid as a financing cash flow. The method used is the choice of the finance director.
Under U.S. GAAP, interest paid and received are always treated as operating cash flows.
Free Cash Flow
Investment bankers and finance professionals use different cash flow measures for different purposes. Free cash flow is a common measure used typically for DCF valuation. However, free cash flow has no definitive definition and can be calculated and used in different ways.