The above table is a simple example of a Cash Flow Statement, which is  one of three key financial statements of a company, the other two being Profit & Loss Statement and Cash Balance.

The cash flow statement shows how much cash a company is generating in a given financial period, such as for one financial year. It is divided into three parts:  (1) cash flows from operating activities; (2) cash flows from investing activities; and (3) cash flows from financing activities.

(1) Cash flows from operating activities

Cash flows from operating activities form the first part of the cash flow statement. It shows how much cash a company generated for its business during a financial period, say for a year. This will show how the company’s cash flow changes from year to year. How the company performed in this area is of  interest to stakeholders because it shows the cash-generating power of the company. As the table above shows, the first cash item in operating activities is net earnings or net income. This figure can be obtained from the Profit & Loss statement – in this case, we are assuming that the net earnings figure in the Profit & Loss statement was 4,000,000. We have next to make some additions to cash (including for non-cash items) and some subtractions from cash.  These cash additions or subtractions need some explanation.

The part on  cash additions and subtractions in the given table shows four items as cash additions (inflows) and one item as  cash subtraction:

(a) Depreciation: 20,000

(b) Decrease in accounts receivable: 30,000

(c) Increase in  accounts payable: 30,000

(d) Increase in taxes payable: 4,000

(e) Inventory: -60,000.

Why are the four items from (a) to (d) considered as cash inflows into the company while (e) is considered a cash outflow?  Let’s examine them one by one.

For the depreciation item, assume the company bought an equipment costing 100,000. To simplify matter, assume that the equipment was paid for in cash when it was acquired. If the equipment has a useful life of five years, it means that it will lose 20,000 in value each year under a “straight line” method of depreciation. So the depreciation cost is 20,000 a year. In the profit & loss statement, this 20,000 would have already been deducted as an operating expense in Year 2013  when computing earnings. In reality, the 20,000 depreciation expense did not leave the company as it was a non-cash item. Why was it  so? Remember the company had already paid 100,000 upfront for the equipment? So while depreciation was a cost in Year 2013 and was deducted as an expense, there was no actual outflow. The 20,000 was  therefore treated in the cash flow statement as an addition.

Next, we look at why a decrease in accounts receivable of 30,000 in the Balance Sheet became a cash inflow of 30,000 in the cash flow statement. Accounts receivable are what others owe the company for products sold to them on credit, meaning the buyers were given a grace period to pay later. For Year 2013, accounts receivable payable fell 30,000, so there was a net flow of  30,000 into the company. This item was therefore a plus item in the cash flow statement. If this situation was in reverse, that is there was instead an increase in accounts receivable, there would then be a cash outlfow and the amount of increase will  be a minus item in the cash flow statement.

An increase in accounts payable means the company is owing others more, say for goods supplied to the company. In the example in the table, the increase in accounts payable was 30,000. That meant the company owed 30,000 more to suppliers at the end of Year 2013 than at the end of Year 2012, resulting in a cash inflow for the company and hence was a plus item in the cash flow statement. If it was the reverse, meaning there was instead  a drop in accounts payable, it would have meant money had gone out of the company and had  to be treated as a cash outflow.

The table shows an increase in taxes payable of 4,000 in Year 2013 and this was treated as a cash inflow. This came about because taxes, while accounted as an expense in the profit & loss statement of a financial year , that amount of money did not leave the company immediately.  Let’s assume that in Year 2012 the tax payable was 20,000 and in Year 2013 it was 24,000.   In Year 2013, there was a cash outflow of 20,000 being taxes for Year 2012.  But Year 2013 saw a cash inflow of 24,000 because this amount, while having been deducted in Year 2013 as an expense in the profit & loss statement, would be  be due for settlement the following year in Year 2014.

There was also an increase of 60,000 in inventory in Year 2013 and this was treated as a cash outflow for obvious reasons. When a company buys more stocks, it means more money flows out. It will still be a cash outflow if the goods are on credit term as this mean an increase in accounts payable.

(2) Cash flow from investing activities

These activities involve acquiring or dispensing of property, plant and equipment (PP&E), corporate acquisitions and any sales or purchases of investments. In the table given, the company spent 1,000,000 on equipment in Year 2013, so 1,000,000 was treated as a cash outflow.

(3) Cash flow from financing activities

Financing activities include transactions with the company’s owners or creditors. In the example in the table, the company issued 20,000 notes to raise funds. The 20,000 notes payable are considered a cash inflow. Some other examples of items that fall under this part of the cash flow statement are:

(a) dividends;

(b) issuance/purchase of common stocks;  and

(c) issuance/repayment of debt.

Recommended reading:

(1) The Five Rules for Successful Stock Investing: Morningstar’s Guide to Building Wealth and Winning in the Market

(2) Analysis for Financial Management, 10th Edition

(3) Financial Statements: A Step-by-Step Guide to Understanding and Creating Financial Reports

(4) Finance & Accounting For Nonfinancial Managers By Stephen A. Finkler