Statement of Cash Flows Basics

There are only a handful of things you need to know when learning to read a Statement of Cash Flows (SCF). You can follow along with Google’s Statement of Cash Flows from its 2014 10-K filing:

1. The SCF records your company’s actual cash performance over a period of time like a month, quarter, or year.

It records the amount of cash entering and leaving your business, and tells where the cash is coming from and how it’s being spent.

2. The SCF is derived from the Income Statement and the Balance Sheet.

But the income statement and the balance sheet were created using the accrual method of accounting.

And the SCF only cares about actual cash!

That’s the actual cash you received from customers during the period. And, the actual cash you paid out to your vendors, employees, and investors during the period.

As a reminder, your Income Statement and Balance Sheet include transactions made on credit. These “on credit” transactions reflect future incoming and outgoing cash. The SCF will care about them in the future. Right now, they need to be stripped away to arrive at actual cash received and spent.

The stripping away process entails converting Net Income (on the income statement) from the accrual method of accounting to the cash method. Here are the transactions that get stripped away from net income:

• Sales from customers who receive credit terms. These customers buy today and pay you in the future, usually in 30 days. The amount resides in accounts receivable.
• Purchases you make on credit. You incurred expenses during this period but will pay for them next period. The amount resides in accounts payable and/or inventory.
• Non-cash activities like depreciation and amortization.

3. Cash activities fall into one of 3 categories:

They happen to be the way in which cash enters and leaves your company.

Operating activities (aka customer-related cash flows)
Cash flow from Operations reflects the inflows and outflows associated with running your business. It’s calculated as follows:

It’s the cash flow resulting from changes in the current assets & current liabilities balances on the balance sheet. Generally, changes made in accounts receivable, inventory, and accounts payable.

Ideally, you’ll want this number to be positive. A positive numbers means that after paying your bills, you have cash left over to invest in growth initiatives.

Investing activities
Cash flow from Investing shows the cash generated (or used) by a company’s for its investment in assets.

It’s the cash flow resulting from changes in the long-term asset balances on the balance sheet.

Usually cash changes from investing are “cash out” items, because cash is used to buy new equipment, buildings, or short-term assets such as marketable securities, or to acquire a company. If a company sells an asset like a building or if it divests one of its divisions, the transaction is reflected as “cash in” for calculating cash from investing.

Financing activities
Cash flow from financing reflects the cash generated (or used) by a company for the financing of its operations.

It’s the cash flow resulting from the changes in the long-term liability and stockholder’s equity balances on the balance sheet.

“Cash in” items include funds raised from investors and proceeds from bank loans. Dividends paid and loan repayments are considered “cash out” items.

4. The bottom line

The last three lines of the SCF summarize your business’s cash position. The net increase (or decrease) in cash over the period is added to the beginning cash balance to arrive at the ending cash balance.

Both the beginning and ending cash balances will tie to the balance sheet.

Originally published at facingthenumbers.com on March 31, 2016.