Cash Flow Statement

The cash flow statement shows the companies cash inflows and outflows over the financial period. It can be classified under three broad heads:

1. Operating cash flows: It includes the cash flows related to the normal day to day functioning of the business. It includes firms’ primary activities of trade. It also includes payment of income taxes.

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2. Investing cash flows: It includes the cash flows relating to buying, selling of fixed assets like plant, machinery, buildings, land, etc. It also includes acquisition or sale of securities or segment, investment in other firm. Broadly it can be stated that it includes transactions that deal with acquisition or sale of long term assets.

3. Financing cash flows: It includes the cash flows relating to issuance or retirement of firms’ debt, debentures, shares and dividend paid to shareholders.

One very important thing to note here is that how a transaction is defined depends on the nature of the business the firm does. The most suitable example can be of banks. While issuing or holding long term securities will be an investing activity for most of the firms, but in the case of banking institutions it will be classified as an operating activity.

The firm's cash flow is quite different from its net income. These differences can arise for at least two reasons:

1. The income statement does not recognize capital expenditures as expenses in the year that the capital goods are paid for. Instead, it spreads those expenses over time in the form of an annual deduction for depreciation.

2. The income statement uses the accrual method of accounting, which means that revenues and expenses are recognized as they are incurred rather than when the cash is received or paid out.

3. Further, the income statement takes into account noncash charges like depreciation, amortisation and write off expenditures which do not result in any actual inflow or outflow. But these transactions are excluded from cash flow statement.

Statement of Cash Flows

Cash flow is the money that is moving (flowing) in and out of your business in a month. Although it does seem sometimes that cash flow only goes one way - out of the business – it does flow both ways.

Cash flow
  • Cash is coming in from customers or clients who are buying your products or services. If customers don't pay at time of purchase, some of your cash flow is coming from collections of accounts receivable.
  • Cash is going out of your business in the form of payments for expenses, like rent or a mortgage, in monthly loan payments, and in payments for taxes and other accounts payable.

Purpose of statement of cash flows

The purpose of the cash flow statement is to show where an entities cash is being generated (cash inflows), and where its cash is being spent (cash outflows), over a specific period of time (usually quarterly and annually). It is important for analyzing the liquidity and long term solvency of a company.

The cash flow statement uses cash basis accounting instead of accrual basis accounting which is used for the balance sheet and income statement by most companies. This is important because a company may accrue accounting revenues but may not actually receive the cash. This could produce profits and taxes payable but not provide the resources to stay solvent.

Importance of cash flow statement

  1. Facilitates to prepare sound financial policies- Company's policies depend on the effective decision making of the management. And for an effective decision making, company needs to go through all the financial statements. And one of those is cash flows, which tells many things about the company's inflows and outflows of cash. Company can accordingly make the policy and prevent them from facing crisis.
  2. Helps to evaluate current cash position- Cash flows show the inflow and outflow of the cash. So, it tells how much cash is left or whether there is an overdraft with the organization after making certain adjustments.
  3. It helps in taking loans from banks and other financial institutions- Banks and financial institutions look in to the cash flows of the business. Banks can judge the credibility and can make the decision accordingly.
  4. Helps the management in taking short term financial decision- Short term financial decision comprises of, short term liabilities and short term assets. If there is more of cashflows and less of inflows then the management will make decision relating to this and try to control the deviation, which may lead to failure.
  5. Statement explains the causes for poor cash position- If any company is having poor cash position or if it is having bank overdraft then it also tells the reason behind that. For example- If a company has purchased a machinery, then its cash is going out. So the company will know whether they have invested and from where their cash is flowing out.

Limitations of Cash Flow Statement

  1. Fails to present net income- Cash flow statements fail to present net income as it doesn't consider the non-cash items. These non-cash items can easily be ascertained by the statement of income. So, it can be used as a supplement to income statements.
  2. Fails to assess the liquidity and solvency position- Practically, cash flow statement does not help to assess liquidity or solvency position of a firm. Proper liquidity position cannot be assessed from the cash flow statement which presents only the cash position at the end of the period. It only helps how much amount of obligation can be met
  3. Not to assess profitability- Profitability of the firm cannot be ascertained by the cash flow statements. Because it doesn't consider any cost or revenue.
  4. Does not assess future cash flows- Since Cash Flow Statement is prepared on the basis of historical cost and, as such, it does not help to know the future/projected cash flows.
Cash Flow Statement

Cash from operating activities usually refers to the net cash inflow reported in the first section of the statement of cash flows. Cash from operating activities focuses on the cash inflows and outflows from a company's main business activities of buying and selling merchandise, providing services, etc. Cash from operating activities excludes the amount spent on capital expenditures such as new equipment and new facilities, the cash used for other long-term investments, and the cash received from the sale of long-term assets. Cash from operating activities also excludes the amount paid to stockholders in dividends or to acquire treasury stock, the amounts received from issuing stock and bonds, and the amounts spent to retire bonds.

Operating cash receipts (inflows):

  • Revenue from the sale of goods and services
  • Interest income (i.e., return on loans)
  • Dividends income (i.e., return on equity securities)
  • Royalties, fees, commissions, and other revenue

Operating cash payments (outflows):

  • Payments to employees for services
  • Payments to suppliers for inventory
  • Payments to lenders for interest
  • Payments to government for taxes
  • Payments to others for operating expenses (e.g., insurance premiums)

Negative operating cash flows, combined with cash inflows from investing (e.g., selling assets) and financing activities (e.g., borrowing), may indicate a serious financial problem. On the other hand, positive operating cash flows combined with negative investing cash flows indicate goods financial performance and growth.

Solved Example on preparing a cash flow statement

Prepare the cash flows from operating activities section of cash flow statement by direct method using the following information:

        December 31	 2011	2010
        Accounts Receivable	 $34,130	$28,410
        Prepaid Rent	 20,000	25,000
        Prepaid Insurance	 6,800	6,000
        Inventory	 23,030	15,450
        Accounts Payable	 14,590	31,300
        Salaries Payable	 8,310	5,120
        Interest Payable	 700	360
        Income Tax Payable	 2,340	0
        Year Ended December 31	2011
        Net Sales	64,970
        Salaries Expense	8,610
        Rent Expense	5,000
        Insurance Expense	3,200
        Interest Expense	1,650

Steps of preparing the statement of Cash Flows

        Cash Flow from Operating Activities:
        Cash Receipts
        From Customers (1)	   $59,250
        Cash Payments
        To Suppliers (2)	   −24,290
        To Employees (3)	   −5,420
        For Purchase of Prepaid Assets (4) −4,000
        Interest (5)	   −1,310
        Income Tax (6)	   −0
        Net Cash Flow from Operating Activities	   24,230

Working Notes

        1) 64,970 + 28,410 - 34,130
        2) 23,030 - 15,450 + 31,300 - 14,590
        3) 5,120 - 8,310 + 8,610
        4) 20,000 + 6,800 + 5,000 + 3,200 - 25,000 - 6,000
        5) 360 - 700 + 1,650
        6) 0 - 2,340 + 2,340

Cash flow from investing activities is an item on the cash flow statement that reports the aggregate change in a company's cash position resulting from any gains (or losses) from investments in the financial markets and operating subsidiaries and changes resulting from amounts spent on investments in capital assets such as plant and equipment.

Here’s a short list of common cash inflows and outflows listing in the investing section of the cash flows statement.


  • Cash collected from:
  • Selling trading, held for sale, and available for sale securities
  • Selling discounted notes
  • Selling long-term productive assets
  • Collecting principle on third party notes that don’t generate sales


  • Cash paid to:
  • Purchase trading, held for sale, and available for sale securities
  • Purchase long-term productive assets
  • Pay principle on third party notes that don’t generate sales

Cash flows from financing activities is a line item in the statement of cash flows. This statement is one of the documents comprising a company's financial statements. The line item contains the sum total of the changes that a company experienced during a designated reporting period that were caused by transactions with owners or lenders to either:

Financing Activities (inflows)

  • Proceeds from Share Capital
  • Issue of Debentures
  • Loan taken from Bank


  • Divident paid to shareholders
  • Interest paid to debentures holders
  • Loan paid
  • Provide long-term funds to the company; or
  • To return those funds to the owners or lenders.
Cash From Bonds Issued$1,000
Cash From New Stock Issued$2,000
Repayment on Existing Loans($200)
Dividends Paid($500)
Repurchase of Existing Stock($700)
Net Cash Flow from Financing Activities$1,600

Format of the Statement of Cash Flow

Format of the Statement of Cash Flow

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