The Anatomy of the Statement of Cash Flows

The Anatomy of the Statement of Cash Flows

Thus far, we have explored two of the three main financial statements used to explore and understand the financial health of a business. Today we examine the Anatomy of the Statement of Cash Flows. Again, this is a bird’s eye view of this report. It is not a detailed in-the-weeds explanation.

In our previous posts, we examined the anatomies of the Income Statement and Balance Sheet. There is a slight difference in what the Statement of Cash Flows reports in comparison to the other two financial statements. This difference has to do with time. In the two former statements, the data in each is based upon a particular time period - in other words it is a representation of the business based upon a snapshot in time. What is different about the Statement of Cash Flows (a.k.a Cash Flow Statement) is that it reflects the flow of cash over time. In other words, from the beginning of the time period selected until the end of the time period selected. We’ll explain below.

Overview

The Statement of Cash Flows reflects the movement of cash within a business over a specific period of time. It reflects cash moving in two directions - in and out of the business. Cash moving into the business is referred to as cash inflow, while cash moving out of the business is referred to as a cash outflow.

It is worth noting that cash referred to in a cash flow statement is not necessarily the physical representation of money. Rather, it is the representative value of items. To be sure, many businesses carry an accounts receivable balance. This is not actual cash in hand, but it is the representation of cash owed to the business, therefore it is counted as positive cash inflow. To the contrary, when a business owes money to suppliers, vendors, etc. (accounts payable), this would be considered a negative to cash flow - as this is cash outflow.

When considering the Statement of Cash Flows it is broken down into three distinct sections. The first is Operating Activities, followed by Investing Activities, and finally Financing Activities. 

Operating Activities

These types of activities would include everyday operations such as sales and payment collection activities from customers, outgoing payments for expenditures such as rent, utilities, maintenance, salaries, etc.

Investing Activities

These types of activities would include investments into long-term assets such as the purchase (or sale) of a building, equipment, or investment tools such as Certificates of Deposits.

Financing Activities

These types of activities would include transactions that reflect how the business finances its operations. For example, if the business borrows money to purchase equipment, vehicles, land, or a building. Also included would be things such as issuing stock, paying dividends, or repurchasing stock.

Putting it all Together

Okay, so now that we understand the three sections of the Statement of Cash Flows and we also understand that the Statement of Cash Flows is a representation of the movement of cash IN and OUT of the business, we can use this information to further understand the financial status and health of the business.

If we look at a business and see that the majority of its cash is being paid out in debt or to vendors and suppliers, we know that they are highly leveraged and that this can negatively impact the overall financial health of the business. This doesn’t leave the business with enough cash to operate which could mean that the business is hanging on for dear life.

On the other hand, if we see that the business has lots of positive cash flow, a greater portion of cash is coming in as opposed to going out, we can make an assumption that the financial health of the business is good and that they are in a position of sustainability and possibly growth. Just to be clear, the Statement of Cash Flows is one of several tools of measuring the financial health of a business. It is not a sole means of measuring as it should be used in conjunction with other financial tools to get the overall financial picture of health of the business

Summary

The Statement of Cash Flows reflects the movement of cash within a business over a period of time. It is a reporting tool that can be used to determine the business’ ability to generate cash, sustain its present activities, and whether expansion is a possibility.