The three financial statements
The cash flow statement
Follow the cash: turn net income into operating cash flow, and see where the rest of the money went.
22 minfoundationMembers
Learning objectives
- Explain the three sections of the cash flow statement and classify transactions into them
- Derive operating cash flow from net income with the indirect method
- Reconcile the net change in cash to the opening and closing cash balances
The first lesson showed that profit is not cash. The cash flow statement is where the two are reconciled. It explains, line by line, why the bank balance moved during the year.
It is the hardest statement to manipulate and often the most revealing. A company reporting rising profits while its operating cash flow shrinks is telling you something important, and this statement is where you'll see it.
Three sections
- Operating activities (CFO): cash generated by the business itself: selling, paying suppliers, staff and tax.
- Investing activities (CFI): buying or selling long-term assets, such as equipment (capital expenditure, or capex).
- Financing activities (CFF): dealings with the providers of capital: borrowing, repaying loans, issuing shares, paying dividends.
The indirect method
Most companies build CFO by starting from net income and adjusting it to cash:
- Add back non-cash expenses such as depreciation. They reduced profit but no cash left.
- Adjust for working capital. If receivables rose, some sales weren't collected, so subtract the increase. If inventory rose, cash went into stock, so subtract it. If payables rose, you kept suppliers' cash longer, so add it.
Included with a Formula Quest membership
The rest of this lesson is for members. Members get the full lesson, including its 3 graded exercises, and every other Finance Quest lesson.