What is the Cash Flow Statement

Like the income statement, the cash flow statement also reflects changes over a period of time, rather than being a snapshot at a fixed point in time as in the balance sheet. This statement reflects all the movements of cash into the company (cash inflow) and out of the company (cash outflow) in a given period of time. This statement is essential for understanding the company's ability to survive over time. It is possible, for example, for a company to be profitable, yet to consume more cash than it has (for instance, due to a delay in receiving some of its revenues) and therefore to find itself in a cash shortage. (A later section on accounting revenues and actual cash flows will give a more detailed discussion.)

The cash flow statement is divided into three components describing the changes in the company's cash flows from operating, investing, and financing activities. We will first demonstrate how the cash flow statement may be constructed on the basis of the company's other main financial statements, namely the balance sheet and the income statement. We will then review the three components of the cash flow statement: the cash flows from operating activities, investing activities, and financing activities. The analysis proposed here is essentially economic, and although it is consistent with the accounting standards for the reporting of cash flows in countries such as the United States, it is not constructed according to such reporting (GAAP) standards.

The starting point for analyzing a company's cash flows is the cash item in the company's balance sheet at the beginning of the period, and the end point is the cash item at the end of the forecasted or analyzed period. The change in the company's cash positions is the difference in its cash between these two points in time. This difference takes into account all of the movements and transactions in which the company was involved. Therefore, this figure alone is insufficient to understand the company's cash needs, cash generation, and cash consumption over the period. Clearly, the value of cash infused into the company as a result of the sale of products or services is different from an inflow of cash to the company created by raising new capital.

The company's cash flow from operating activities is composed, in principle, of actions revolving the sale of products and services. Accordingly, expenses relating to the creation of such cash flows, such as the acquisition of raw materials, sale expenses, marketing expenses, and general expenses, as well as tax payments, are some of the components of the company's cash outflow resulting from operating activities.

The company's cash flow from investing activities is composed of actions such as the sale of real and financial assets or the repayment of long-term loans given to third parties. Accordingly, acts such as the acquisition of assets and investments in equipment and long-term financial assets are some of the components of the company's cash outflow resulting from investing activities, as are the receipt of dividends and interest from real and financial investments. The main component of the cash flow from investing activities is usually the change in the company's net fixed assets. As mentioned above, the company's net fixed assets at the end of a period are equal to its net fixed assets at the beginning of the period, plus assets purchased over the period, minus depreciation accumulated over the period and minus net sales of assets sold over the period.

Finally, the company's cash flow from financing activities is composed of shares and notes and debentures issued and long- or short-term loans taken. Accordingly, the re-purchase of the company's own shares, repayment of notes and debentures and other long-term debts, and the payment of dividends and interest on debts compose the company's cash outflow resulting from financing activities.

At this point it should be mentioned that there might be material differences between the classification of the cash flows for internal company analysis and the classification required by GAAP. The main differences typically relate to the company's financing expenses. In the above description, they are included in the cash flows from financing activities, whereas, according to GAAP, they are included in the cash flows from operating activities. The analytical difference between the two is that decisions with respect to the taking of loans are managerial decisions pertaining to the company's capital structure and should therefore be classified as cash flows from financing activities for an internal analysis of the business, as well as for free cash flow-based valuation