What you will learn
- Explain what the cash flow statement shows and why cash is harder to fake than profit
- Sort transactions into operating, investing, and financing activities
- Add the three sections to find the net change in cash
- Use the gap between profit and operating cash flow as an early warning
Net income can be polished and shaped by accounting choices. Cash is much harder to fake, because it is either in the bank or it is not. The cash flow statement sets aside the accrual estimates and shows exactly how much real cash flowed in and out over a period, and where it came from. For many analysts this is the single most revealing of the three statements, and it is the reality check that ties the whole unit together.
The cash flow statement for beginners (Accounting Stuff)
A beginner walkthrough of the three sections. Notice how the statement starts from profit and works its way to the actual change in cash.
Three sources of cash
- Cash flow from operating activities, or CFO: cash generated by the core business of selling products and services. This is the engine, and you want it healthy and positive.
- Cash flow from investing activities, or CFI: cash spent or received from buying and selling long-term assets, including capital expenditures (capex) and acquisitions. It is often negative for growing companies, which is normal.
- Cash flow from financing activities, or CFF: cash from raising or repaying money, including issuing or repaying debt, issuing or buying back shares, and paying dividends.
Key terms
- Operating activities (CFO)
- Cash from the day-to-day business of selling goods and services.
- Investing activities (CFI)
- Cash used to buy, or received from selling, long-term assets like equipment.
- Financing activities (CFF)
- Cash from borrowing, repaying debt, issuing or buying back shares, and paying dividends.
- Capital expenditure (capex)
- Cash spent on long-term assets like factories and machines. It sits in the investing section.
- Non-cash expense
- A cost like depreciation that lowers profit but does not move any cash in the period.
Which section does it belong in?
Match each transaction to the cash flow section it appears in.
Reconciling profit to cash
The most common layout, called the indirect method, starts with net income from the income statement and adjusts it back to cash. It adds back non-cash expenses like depreciation, which lowered profit but took no cash out. It also adjusts for changes in working capital. For example, if unpaid customer bills, called receivables, rise, it means revenue was recorded but the cash has not arrived yet, so that increase is subtracted. The result reconciles accrual profit to the actual change in cash.
From profit to operating cash flow
A company reports 100,000 dollars of net income. It recorded 40,000 of depreciation, and its receivables rose by 25,000 during the year. What is its operating cash flow using the indirect method?
- Start with net income. Begin at 100,000 dollars.
- Add back depreciation. Depreciation is non-cash, so add 40,000, giving 140,000.
- Subtract the rise in receivables. Receivables rose 25,000, meaning that much revenue was not collected in cash, so subtract it: 140,000 minus 25,000.
Why it matters: Profit and operating cash flow are related but different. Non-cash charges are added back, and cash tied up in unpaid bills is subtracted.
Find the net change in cash
In a year, a company had operating cash flow of 200,000 dollars, investing cash flow of minus 120,000 dollars, and financing cash flow of minus 30,000 dollars. What was the net change in cash?
You can fake profit for a while. You cannot fake cash for long. The cash flow statement is where the truth tends to surface.
The reality-check power
Here is where it gets useful. Compare net income to operating cash flow over several years. If a company keeps reporting rising profits while its operating cash flow stays flat or falls, that gap is a warning that the earnings may not be backed by real cash. We develop this idea fully in the quality of earnings lesson later. One more connection to notice: the net change in cash on this statement equals the change in the cash line on the balance sheet, which is one of the ways the three statements lock together.
Cash flow statement explained (The Finance Storyteller)
A clear second explanation that keeps stressing why cash can differ from profit. Watch for the link back to the income statement and balance sheet.
Profit rising, cash not
Over three years a company's net income climbs steadily, but its operating cash flow is flat and its receivables keep ballooning. What does a careful analyst suspect?
When profit rises but operating cash flow does not, and receivables balloon, the earnings may not be cash-backed. It is a signal to dig deeper.You now have all three statements. Before we start turning them into ratios, we need to look closely at a few tricky topics that decide the numbers, starting with the rules for when a company is even allowed to call something revenue.