Understanding the Cash Flow Statement | ABC-Amega (2024)

The Cash Flow Statement – also referred to as a statement of cash flows or funds flow statement – is one of the three financial statements commonly used to gauge a company’s performance and overall health. The other two financial statements — Balance Sheet and Income Statement — have been addressed in previous articles.

As the name implies, the Cash Flow Statement provides information about an organization’s cash inflows and outflows over a specified time period. Simply put, it reveals how a company spends its money (cash outflows) and where that money comes from (cash inflows).

This statement is the best resource for testing a company’s liquidity because it shows changes over time, rather than absolute dollar amounts at a specific point in time. It’s also useful in determining the short-term viability of a company.

It’s important to note that the Cash Flow Statement reflects a firm’s liquidity. It does not show profitability – the Income Statement does that.


Cash Flow Statement: Acme Manufacturing

Cash Flow From Operations
Net Income$138,100
Additions to Cash
Decrease in Accounts Receivable$13,000
Increase in Accounts Payable$12,000
Increase in Taxes Payable$8,000
Subtractions from Cash
Increase in Inventory($100,000)
Net Cash From Operations$126,600
Cash Flow From Investing
Cash Flow From Financing
Notes Payable$10,025

How the Cash Flow Statement is Prepared

There are two methods of preparing the Cash Flow Statement: direct and indirect.

  1. The direct method utilizes actual cash flow information from the company’s operations. It presents major classes of gross cash receipts and payments. The direct method would most likely be used by small firms doing their accounting on a cash rather than an accrual basis.
  2. The indirect method derives the data from the Income Statement and from changes on the Balance Sheet from one period to the next. Both the Income Statement and the Balance Sheet are based on accrual accounting.

Note #1: Net Income on the Acme Manufacturing’s 2020 Consolidated Statement of Cash Flows is $138,100. This number was taken from Net Income as listed on the Acme Manufacturing 2020 Consolidated Statements of Income.

The U.S. GAAP (Generally Accepted Accounting Principles) requires that a Cash Flow Statement prepared by the indirect method be included in financial statements, even if it is also prepared by the direct method. Therefore, most companies use the indirect method and the rest of this article refers only to the indirect method using Acme Manufacturing’s 2020 data.

Components of the Cash Flow Statement and What They Tell Us

This statement organizes and reports cash in three categories: operating, investing, and financing.

Operating Activities

This represents the key source of an organization’s cash generation. It’s considered by many to be the most important information on the Cash Flow Statement.

This section of the statement shows how much cash is generated from a company’s core products or services. A strong, positive cash flow from operations (especially over time) is a good sign of a healthy company.

Operating Activities starts with the Net Income number from the Income Statement.

Example #1: Acme Manufacturing’s Net Income numbers on the Income Statement and the Cash Flow Statement are the same.

Net Income
(Income Statement, line 16)
Net Income
(Cash Flow Statement, line 2)

If all of a company’s operating revenues and expenses were in cash, then Net Cash Provided by Operating Activities (Cash Flow Statement) would equal Net Income (Income Statement). However, this is rarely the case. Typically, adjusting Net Income on the Cash Flow Statement is based on an increase or decrease in cash calculated from changes on the Balance Sheet from one period to the next.

[Cash Flow Statement]

Example #2: Merchandise Inventories on Acme Manufacturing’s Consolidated Balance Sheet

Merchandise Inventories
(Balance Sheet)
Difference in inventory
(2020 over 2019)
158,600 – 58,600 = 100,000

The increase in merchandise inventories in 2020 results in a negative adjustment of the same amount ( $100,000) on the 2020 Acme Manufacturing Consolidated Statement of Cash Flows.

Most of these adjustment items can either result in an increase or decrease in cash from operating activities. Exceptions would be adjustments for depreciation and amortization, which are always an increase to Net Income on the Cash Flow Statement.

Look for consistent levels of cash flow from Operating Activities over time, indicating the company will probably continue to be able to fund its operations.

[Cash Flow Statement]

Investing Activities

This section records changes in equipment, assets, or investments.

Cash changes from investing are generally considered “cash outflows” because cash is used to purchase equipment, buildings, or short-term assets. When a company divests an asset, the transaction is considered a “cash inflow.” A healthy company generally invests continually in plant, equipment, land and other fixed assets.

Financing Activities

Changes in debt, loans or stock options, long-term borrowings, etc. are accounted for under Financing Activities.

When capital is raised, it is considered “cash in”; when dividends are paid or debt is reduced, “cash out”. The Financing Activities section shows how borrowing affects the company’s cash flow.

“Bottom Line”

The bottom line on the statement is the Net Increase (Decrease) in Cash and Cash Equivalents. It’s determined by calculating the total cash inflows and outflows for each of the three sections in the Cash Flow Statement.

The 2020 Net Increase (Decrease) in Cash and Cash Equivalents on the Cash Flow Statement should equal the difference between the 2020 and 2019 Cash and Cash Equivalents figures on the Balance Sheet.

Example #3: Acme Manufacturing 2020 Balance Sheet Net Decrease in Cash and Cash Equivalents


Statement of Cash Flows

Net Cash (Operating Activities)

– Net Cash (Investing Activities)

+ Net Cash (Financing Activities)

$126,600 (operating)
– $73,000 (investing)
+ $10,025 (financing)
$226,600 (operating)
– $83,500 (investing)
+ $12,025 (financing)
Bottom Line$63,625$155,125

[Cash Flow Statement]

Supplemental Information

There is a fourth section, titled “Supplemental Information”, which is often included with the primary three sections of the Cash Flow Statement. It reports the exchange of significant items, such as company stock for company bonds, which did not involve cash.

This section also records the amount of income taxes and interest paid. The Acme Manufacturing Consolidated Statement of Cash Flows does not include Supplemental Information.

Using the Cash Flow Statement to Determine the Financial Health of an Organization

The statement shows how a company raised money (cash) and how it spent those funds during a given period. It’s a tool that measures a company’s ability to cover its expenses in the near term.

Generally, a company is considered to be in “good shape” if it consistently brings in more cash than it spends. Cash flow reflects a company’s financial health, and its ability to pay its bills and other liabilities.

In most cases, the more cash available for business operations, the better. However, a low or negative cash flow in one year could result from a company’s growth strategy – and, therefore, not be a real issue. As with all financial analysis, it’s important to determine the company’s cash flow trend.

“High Quality” Net Income

To determine if a company’s net income is of “high quality”, compare the Net Cash Provided by Operating Activities to the Net Income. Both of these figures are found on the Cash Flow Statement. The Net Cash Provided by Operating Activities should be consistently (over time) greater than the Net Income.

Note #3: On Acme Manufacturing’s Consolidated Statement of Cash Flows, you can see that 2020 Net Cash Provided by Operating Activities is less than Net Income. This is not a good sign. It’s important to understand, however, where the decrease is coming from – so a more thorough analysis over a greater period of time would help.

Cash Flow-based Financial Ratios

The problem with using the Balance Sheet for liquidity analysis is that it only presents data that measures where the organization stands at a particular point in time.

The problem with the Income Statement is that it includes many non-cash allocations, accounting conventions, accruals and reserves that have nothing to do with cash.

Utilizing the Cash Flow Statement for liquidity analysis results in a more dynamic picture of the resources a company has to meet its current financial obligations.

1. Cash Flow to Sales = Operating Cash Flow ÷ Net Sales

This ratio determines how much cash is being generated for each dollar of sales. Obviously, the higher the number, the better.

Example #4: Acme Manufacturing Cash Flow to Sales

Net Cash Provided by Operating Activities
(Cash Flow Statement)
Net Sales
(Income Statement)
Cash Generated for Each Dollar of Sales
2020$126,600 ÷$1,864,000 =$0.06 or 6%
2019$226,600 ÷$1,790,200 =$0.13 or 13%

Is this good or bad? At first glance, six cents cash generated by each one dollar of sales in 2020 isn’t great, but not bad. What is troubling, however, is that Acme Manufacturing’s Cash Flow to Sales has decreased by seven cents from the previous year, which is a major cause for concern. To make a more accurate assessment, you should compare this performance to industry benchmarks and get to the root of what caused such a decrease.

[Cash Flow Statement]

2.Operation Index = Net Cash from Operations ÷ Net Income after income tax

This measures the relationship between operating cash flows and profit. The higher the percentage, the better.

Example #5: Acme Manufacturing Operation Index

Net Cash Provided by Operating Activities
(Cash Flow Statement)
Net Income
(Income Statement)
Operation Index
2020$126,600 ÷$138,100 =91.6%
2019$226,600 ÷$242,400 =93.5%

[Cash Flow Statement]

3.Operating Cash Flow Ratio = Cash Flow from Operations ÷ Current Liabilities

This ratio is used to assess whether an operation is generating enough cash to cover current liabilities.

If the ratio falls below 1.00, the company isn’t bringing in enough cash and will have to find other sources to finance its operations.

Example #6: Acme Manufacturing Operating Cash Flow (OCF) Ratio

Net Cash Provided by Operating Activities
(Cash Flow Statement)
Total Current Liabilities
(Balance Sheet)
Operating Cash Flow Ratio
2020$126,600 ÷$558,800 =$0.23
2019$226,600 ÷$560,800 =$0.40

[Cash Flow Statement]


Looking at the Balance Sheet and Income Statement in previous articles, Acme Manufacturing has taken on too much inventory in 2020 and is negatively affecting its free cash flow. The overall impression from the Cash Flow Statement raises concern regarding Acme Manufacturing’s ability to pay its short-term liabilities (including payments due creditors).

The Income Statement and Balance Sheet are important tools for evaluating a company’s health. However, the Cash Flow Statement is an important complement to these, and should not be overlooked.

These articles give you a basic understanding and the tools you need. Use them to improve your credit decision-making process by examining all three of these financial statements to get the best idea of how a current or potential customer’s company is doing.

Want to learn more about credit management? Check out these other articles below:

  • Basic Outline for Developing a Credit Policy
  • Cash Flow and DSO
  • Credit and Collection Policy Basics
  • Credit Extensions are Loans
  • Credit Group Spotlight: GAIN
  • Credit Group Spotlight: NCCA
  • D/P, D/A and Their Use in International Sales Transactions
  • DuPont Analysis
  • Final and Binding Arbitration: A Quicker, Cost Effective Alternative to a Lawsuit
  • Measure and Manage Collection Efficiency Using DSO
  • Receivables Based Financing
  • Resolving A/R Disputes
  • The Proforma Invoice and Its Value in Export Sales
  • Understanding the Balance Sheet
  • Understanding the Income Statement

To learn more about our commercial collection agency services, contact us at 844.937.3268 today!

Understanding the Cash Flow Statement | ABC-Amega (2024)


What is cash flow statement answers? ›

Gives details about spending: A cash flow statement gives a clear understanding of the principal payments that the company makes to its creditors. It also shows transactions which are recorded in cash and not reflected in the other financial statements.

What is the basic understanding of the cash flow statement? ›

A cash flow statement is a financial statement that shows how cash entered and exited a company during an accounting period. Cash coming in and out of a business is referred to as cash flows, and accountants use these statements to record, track, and report these transactions.

How can you interpret a cash flow statement? ›

To interpret your company's cash flow statement, start by looking at the inflows and outflows of cash for each category: operating activities, investing activities, and financing activities. If all three areas show positive cash flow, your business is likely doing well (although there are exceptions).

What is the cash flow statement easily explained? ›

What is a statement of cash flows? A cash flow statement is a financial statement that summarizes the amount of cash flowing into and out of a company. This includes all cash inflows a company receives from its ongoing operations and external investment sources.

What is the best explanation of cash flow? ›

Cash flow refers to money that goes in and out. Companies with a positive cash flow have more money coming in, while a negative cash flow indicates higher spending. Net cash flow equals the total cash inflows minus the total cash outflows.

What is cash flow analysis answer? ›

Cash flow analysis refers to the evaluation of inflows and outflows of cash in an organisation obtained from financing, operating and investing activities. In other words, we can say that it determines the ways in which cash is earned by the company.

What is a good cash flow ratio? ›

A high number, greater than one, indicates that a company has generated more cash in a period than what is needed to pay off its current liabilities. An operating cash flow ratio of less than one indicates the opposite—the firm has not generated enough cash to cover its current liabilities.

What is the most important number on a statement of cash flows? ›

Regardless of whether the direct or the indirect method is used, the operating section of the cash flow statement ends with net cash provided (used) by operating activities. This is the most important line item on the cash flow statement.

How do cash flow problems usually start? ›

Cash flow problems usually start when a business isn't paying attention to the amount of money they're bringing in each month. If a company is spending like normal but not aggressively working to get accounts receivable up to date, it can quickly find itself with negative cash flow.

How to calculate cash flow? ›

Free Cash Flow = Net income + Depreciation/Amortization – Change in Working Capital – Capital Expenditure. Operating Cash Flow = Operating Income + Depreciation – Taxes + Change in Working Capital. Cash Flow Forecast = Beginning Cash + Projected Inflows – Projected Outflows = Ending Cash.

What is a cash flow statement quizlet? ›

Statement of Cash Flows. Shows the changes in cash for the same period of time as that covered by the income statement. The cash flow statement shows all sources of cash and all of the uses of cash. Provides information about cash receipts (inflows) and cash payments (outflows).

What does a statement of cash flows help answer? ›

A statement of cash flows helps answer all of the following: - What explains the changes in the cash account?- Where does a company spend its cash?- How does a company receive its cash?

What is cash flow also known as? ›

It means it notes down the income earned through operations and other activities and the expenses incurred and paid to manage the routine activities. Hence, it is also referred to as the income and expense statement.

What is cash flow in a business? ›

Cash flow is a measurement of the amount of cash that comes into and out of your business in a particular period of time. When you have positive cash flow, you have more cash coming into your business than you have leaving it. When you have negative cash flow, the opposite is true.


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