Updated: Feb 9
Like the balance sheet, the cash flow statement is another key financial statement produced each year by public companies. In this Investing 101 article, we’re going to have a look into the cash flow statement. What information does it show? Why is it important?
The Cash Flow Statement
The cash flow statement, or the statement of cash flows, simply summarizes the amount of cash and cash equivalents entering and leaving a company. Below is a real-world example, taken from Amazon’s 2017 annual report.
As you can see, there are three main sections to the cash flow statement – operating activities, investing activities and financing activities.
Cash Flow from Operating Activities
Cash flow from operating activities includes any cash received or spent by a company on a day-to-day basis. This includes revenue generating activities, such as the sale of products and services, along with any purchases and other expenses a company might have.
To work out the operating cash flow, we first take the net income from the bottom of the income statement. This value is then adjusted by adding back any non-cash expenditures, such as depreciation, and then accounting for changes in working capital (the current assets minus the current liabilities). The total cash flow from operations can be calculated using the following equation.
Cash Flow from Operations = Net Income + Non-Cash Items + Changes in Working Capital
Cash Flow from Investing Activities
Investing cash flow is exactly what it says on the tin and includes the long-term uses of cash for investment purposes. This section would typically include things like the cash flows associated with buying or selling property, plant, and equipment (PP&E) along with any other financial assets. Plant assets are defined as any asset that has a useful lifespan of more than one year and include items such as vehicles, furniture and fixtures. The money a company spends on buying PP&E is known as capital expenditure (CapEx).
It is fairly common to see negative cash flows in this section. In the case of Amazon, they might be buying warehouses or expanding existing ones. Big purchases like this would have a negative cash flow initially, but normally have a positive cash flow in the long term.
Cash Flow from Financing Activities
This includes any cash generated and/or spent on financing activities. Financing activities include things like dividend payments, stock repurchases, bond offerings and loans. The total cash flow from operations is then given as,
CFF = CED – (CD + RP)
Where CFF is cash flow from financing, CED is cash in flows from issuing debt and equity, CD is cash paid in dividends and RP is the repurchase of debt and equity.
Free Cash Flow
Using the information from the cash flow statement it is possible to calculate a very useful financial metric, free cash flow. This is a measure of the “free” cash available to a company after accounting for expenditures and can be used to reduce debt, expand operations, and pay dividends. It is calculated using the following equation.
Free Cash Flow = Operating Cash Flow – Capital Expenditures
A company with good free cash flow will look very attractive to investors. It shows that any expected dividends are likely to be paid and can also indicate a healthy financial future for the company.
Cash flow is extremely important to investors. Is money flowing into the company, or is it flowing out? A company with good cash flow will be able to expand operations, buy new equipment, reduce its debt, and could even acquire a new company.
The cash flow statement is a very powerful tool used by analysts, but it doesn’t produce the full picture. Instead, analysts use it in conjunction with the income statement and balance sheet to help gain a much deeper understanding into how a company operates.