What It Measures
Cash inflows and cash outflows over a specific period of time, typically a year.
Why It Is Important
Cash flow is a key indicator of financial health, and it demonstrates to investors, creditors, and other core constituencies a company’s ability to meet obligations, finance opportunities, and generally “come up with the cash” as needs arise. Cash flow that is wildly inconsistent with, say, net income, often indicates operating or managerial problems.
How It Works in Practice
In its basic form, a cash flow statement will probably be familiar to anyone who has been a member of a club that collects and spends money. It reports funds on hand at the beginning of a given period, funds received, funds spent, and funds remaining at the end of the period.
That formula still applies to a business today, even if creating a cash flow document is significantly more complex. Cash flows are divided into three categories: cash from operations; cash investment activities; and cash financing activities. Companies with holdings in foreign currencies use a fourth category: effects of changes in exchange rates on cash.
A standard direct cash flow statement is shown below.
|CRD Inc. statement of cash flows for year ended December 31, 20__|
|Cash flows from operations ($)|
|Adjustments to net earnings|
|Other adjustments to earnings||4,000|
|Net cash flow from operations||87,000|
|Cash flows from investment activities ($)|
|Purchases of marketable securities||−58,000|
|Receipts from sales of marketable securities||45,000|
|Loans made to borrowers||−16,000|
|Collections on loans||11,000|
|Purchases of plant and real estate assets||−150,000|
|Receipts from sales of plant and real estate assets||47,000|
|Net cash flow from investment activities||−121,000|
|Cash flows from financing activities ($)|
|Proceeds from short-term borrowings||51,000|
|Payments to settle short-term debts||−61,000|
|Proceeds from issuing bonds payable||100,000|
|Proceeds from issuing capital stock||80,000|
|Net cash flow from financing activities||106,000|
|Net change in cash during period||72,000|
|Cash and cash equivalents, beginning of year||27,000|
|Cash and cash equivalents, end of year||99,000|
Tricks of the Trade
A cash flow statement does not measure net income, nor does it measure working capital.
A cash flow statement does not include outstanding accounts receivable, but it does include the preceding year’s accounts receivable (assuming these were collected during the year for which the statement is prepared).
Add to a cash inflow any amounts charged off for depreciation, depletion, and amortization, because cash was actually spent.
Cash equivalents are short-term, highly liquid investments, although precise definitions may vary slightly by country. These should be included when recalculating the movement of cash in the period.
There are alternative ways to present cash flow from operations. Some texts, for example, omit earnings and adjustments, and list instead cash and interest received, cash and interest paid, and taxes received.