A Statement of Cash Flows is a core financial report that shows how cash moves into and out of a business over a specific period. Unlike the income statement, which records revenues and expenses on an accrual basis, the cash flow statement focuses solely on actual cash activity. This makes it an essential tool for understanding a company’s liquidity, financial health, and ability to meet short-term obligations.
Below are the key points every reader should understand when reviewing a Statement of Cash Flows.
1. Structure of the Statement
The Statement of Cash Flows is divided into three primary sections, each representing a different type of business activity:
Operating Activities
This section details cash generated or used by the company’s core business operations. It includes:
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Cash received from customers
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Cash paid to suppliers and employees
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Interest and tax payments
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Adjustments for non-cash items like depreciation
Most companies use the indirect method, which begins with net income and adjusts for changes in working capital and non-cash expenses.
Investing Activities
This reflects cash used for, or generated by, investments in long-term assets. Common examples include:
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Purchases or sales of property, equipment, or vehicles
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Purchases or sales of investments
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Loans made to or collected from other entities
Cash outflows in this section often indicate growth, such as buying equipment or technology.
Financing Activities
This section shows how the business obtains or repays capital. It includes:
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Borrowing or repaying loans
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Issuing or buying back stock
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Paying dividends to shareholders
These activities explain how the company funds operations and expansion.
2. Net Cash Flow and Liquidity
The sum of the three sections results in the net increase or decrease in cash for the period. This figure reveals:
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Whether the company is generating enough cash to sustain operations
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Whether it is relying on financing or asset sales
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Its ability to pay bills, make investments, and plan for the future
A company may be profitable on paper yet still face cash shortages, which is why this statement is crucial.
3. Cash Flow vs. Profitability
One of the most important insights the Statement of Cash Flows provides is the difference between profit and cash:
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Profit can be influenced by non-cash items, estimates, and accrual accounting rules
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Cash flow shows real liquidity
Investors and lenders often prioritize cash flow over profit because it reflects the company’s true ability to operate.
4. Indicators of Financial Health
A strong cash flow statement provides important indicators such as:
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Positive operating cash flow, meaning the core business is healthy
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Negative investing cash flow, often signaling growth and expansion
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Manageable financing cash flows, showing balanced borrowing and repayment
Patterns across multiple periods can reveal trends in stability, growth, or potential risk.
5. Importance for Decision-Making
Business owners, investors, and lenders use the Statement of Cash Flows to:
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Assess short-term liquidity and risk
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Evaluate whether growth is sustainable
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Determine the company’s capacity for loans or dividends
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Understand how management allocates resources
It is one of the most reliable tools for evaluating financial strength.
Conclusion
The Statement of Cash Flows offers a clear and practical view of how a business generates, spends, and manages its cash. By analyzing operating, investing, and financing activities, stakeholders can gain a deeper understanding of the company’s financial position and its ability to grow, meet obligations, and create value over time. At Charted Legacy Solutions, we are trained to interpret and provide valuable insight into all your financial statements. Contact Us to find out how we can help you understand them so that it will be easier to grow your business.
