A cash flow statement is a financial statement that describes the sources of cash in a business and how that cash was spent. It does not include non-cash items seen in other financial statements such as depreciation. This makes it useful for determining the short-term viability of a company, particularly liquidity and solvency.

The cash flow statement is similar to the income statement in that it records a company’s performance over a specified period of time – normally a year. A difference is that the income statement also takes into account some non-cash accounting items such as depreciation, accrued expenses and provisions for bad debts. The cash flow statement excludes all non-cash items and shows exactly how much actual cash the a business has generated. Cash flow statements show how companies have performed in managing inflows and outflows of cash. It provides a sharper picture of a company’s ability to pay creditors, and finance growth.

It is possible for a company that is profitable  to fail if there isn’t enough cash on hand to pay bills. Comparing the amount of cash generated to outstanding debt, known as the “operating cash flow ratio,” illustrates the company’s ability to service its loans and interest payments.

Unlike the varying treatments on some transactions in accounting , there is little a company can do to manipulate its cash flow. Analysts will look closely at the cash flow statement of any company in order to understand its overall health.

The cash flow statement

Cash flow statements classify cash receipts and payments according to whether they are operating, investing, or financing cash flows. A cash flow statement is divided into sections by these same three functional areas within the business:

• Cash from Operations – this is cash generated from day-to-day business operations.

• Cash from Investing – cash used for investing in assets, as well as the proceeds from the sale of other businesses, equipment, or other non-current assets.

• Cash from Financing – cash paid or received from issuing and borrowing of funds. This section also includes dividends paid – although dividends can be listed under cash from operations.)

• Net Increase or Decrease in Cash – increases in cash from previous year will be written normally, and decreases in cash are typically written in (brackets). The net movement in cash should be the differences between the opening and closing balances on the bank account (as per the balance sheet).

There are two ways to prepare a cash flow statement according to International Accounting Standard (IAS7) – the direct method and the indirect methods. The direct methods means looking at the cash records of the business and classifying according to the headings above (operations, finance and investing, which are specified by IAS7). While the direct methods seems practical, most of the time the indirect method is used. This is because IAS7 only requires a cash flow statement to be produced annually (this does not mean internal cash flow forecasts won’t be needed). The indirect method uses the income statement and balance sheet to extract cash flows. While this takes a bit of work, the information is easily available.