Cash Flow Statement

Cash Flow Statement: tracking real money
The Cash Flow Statement (CFS, Statement of Cash Flows) shows where cash came from and where it went during a period. Unlike the P&L, which is based on accrual accounting, the CFS shows actual cash flows—a critically important piece of information for evaluating the liquidity and viability of a company.

Why Cash Flow is important
“Cash is king”—profit is not equal to cash. A company may show a profit but have negative cash flow (and vice versa). Reasons for the discrepancy: revenue recognition (sales on credit increase profit, but not cash); future period expenses (prepayments); non-cash expenses (depreciation); capital expenditures (do not immediately affect the P&L). Bankruptcies often occur due to cash flow problems, not a lack of profit. A company with good profits can go bankrupt if it cannot pay its bills. Therefore, investors and lenders carefully analyze the CFS.

Three sections of the Cash Flow Statement
Operating Activities (CFO): cash flows from main operations—sales, operating expenses. A healthy company generates positive CFO.

Investing Activities (CFI): cash flows from investing activity—purchase/sale of fixed assets, acquisitions, investments. Growing companies usually have negative CFI (investing in development).

Financing Activities (CFF): cash flows from financing activities—issuing/repaying debt, issuing/buying back shares, dividends. Reflects interaction with capital providers.

Operating Cash Flow: indirect method
The indirect method is the most common. It starts with Net Income and adjusts for non-cash items and changes in working capital.

Adjustments for non-cash items:

• • Depreciation & Amortization (add back, since no cash outflow actually took place);
• • Stock-based compensation (non-cash expense);
• +/- Deferred taxes (temporary differences);
• +/- Gains/Losses on asset sales (relate to investing activities).

Changes in working capital:

• • Increase in Accounts Receivable (sales on credit—profit exists, but no cash);
• • Decrease in Accounts Receivable (cash received from customers);
• • Increase in Inventory (purchased inventory—cash outflow);
• • Increase in Accounts Payable (received goods, haven’t paid yet—“free” financing).

Formula:
CFO = Net Income + Non-cash expenses - Increase in Operating Assets + Increase in Operating Liabilities.

Operating Cash Flow: direct method
The direct method shows actual cash receipts and payments:

• Cash collected from customers;
• Cash paid to suppliers;
• Cash paid for salaries;
• Cash paid for taxes;
• etc.

The direct method is more intuitive but is rarely used—it requires detailed tracking of cash flows by category. IFRS and US GAAP prefer the direct method but allow indirect. In practice, over 95% of companies use the indirect method.

Investing Activities
Typical items:

• Capital Expenditures (CAPEX)—purchase of fixed assets, usually an outflow;
• Proceeds from sale of assets—sale of fixed assets, inflow;
• Acquisitions—purchase of other companies, outflow;
• Purchases/Sales of investments—investing in securities.

Negative CFI is usually a good sign: the company is investing in growth. Positive CFI can indicate an asset sale—a red flag if not explained strategically.

Financing Activities
Typical items:

• Issuance of debt—obtaining loans, issuing bonds, inflow;
• Repayment of debt—debt repayment, outflow;
• Issuance of stock—stock issuance, inflow;
• Share repurchases—buyback of shares, outflow;
• Dividends paid—dividend payments, outflow.

CFF reflects capital structure decisions—how the company finances itself and returns capital to shareholders.

Connection with the Balance Sheet and P&L
Change in Cash on the balance sheet = CFO + CFI + CFF. The Cash Flow Statement explains how cash balances changed. Net Income from the P&L is the starting point for CFO (indirect method). D&A from the P&L is added back in CFO. CAPEX in CFI is linked to changes in PP&E on the balance sheet (taking D&A into account). Debt issuance/repayment is linked to changes in debt on the balance sheet.

Free Cash Flow (FCF)
Free Cash Flow is cash flow available for distribution to capital providers after necessary investments.
FCF = CFO - CAPEX (simplified formula).
More details—in the next module.

FCF is a key indicator for business valuation. The DCF model is based on forecasting FCF. A company generating stable positive FCF can pay dividends, buy back shares, repay debt, make acquisitions.

Analysis of the Cash Flow Statement
Comparison of CFO and Net Income: if CFO is consistently below Net Income, the quality of earnings is in question (too many accruals, aggressive revenue recognition).

CAPEX trends: CAPEX should roughly match Depreciation to maintain assets (maintenance CAPEX). Exceeding this indicates growth investments.

Cash conversion cycle: how many days it takes to turn inventory into cash (through sales and collection). Improving the CCC increases CFO.