A cash flow statement is a financial statement that reports how an entity's cash and cash equivalents changed during an accounting period by classifying cash inflows and outflows into operating, investing and financing activities. Its purpose is to explain the movement in cash rather than merely report accounting profit. Cash flow information is particularly important because a profitable business can experience liquidity problems if cash is tied up in receivables, inventory or investment, while a business can temporarily generate cash despite reporting a loss. The cash flow statement therefore complements the income statement and balance sheet by showing the actual movement of cash and cash equivalents during the reporting period.
Operating activities generally relate to the entity's principal revenue-producing activities and other activities that are not classified as investing or financing. Cash received from customers and cash paid to suppliers and employees are typical operating cash flows. Interest and taxes can be classified differently under different accounting frameworks and circumstances, so the precise presentation should be checked against the applicable standards. The operating section is important because it provides information about the cash generated or consumed by the underlying business activities. A business that repeatedly requires external financing simply to fund ordinary operations may have a different financial profile from one that consistently generates operating cash.
Investing activities generally concern the acquisition and disposal of long-term assets and investments that are not considered cash equivalents. Cash paid to purchase property, plant and equipment is a common investing outflow, while proceeds from selling such assets are investing inflows. Acquisitions of other businesses and certain investments can also appear in this category. Capital expenditure is therefore often visible in investing cash flows even though the associated accounting expense may be recognised over several years through depreciation. This distinction is one reason why profit and cash flow can diverge substantially.
Financing activities generally concern transactions that change the entity's contributed equity or borrowings. Proceeds from issuing shares or taking out loans can create financing inflows, while repayment of borrowings, certain share repurchases and dividend payments can create financing outflows, subject to the applicable accounting framework. Lease-related cash flows can have specific classification requirements. Financing cash flows help users understand how an organisation funds its operations and investment and how it returns capital to owners or repays providers of finance.
The operating cash-flow section can be presented using the direct or indirect method. Under the direct method, major categories of cash receipts and payments are presented directly, such as cash received from customers and cash paid to suppliers. Under the indirect method, which is widely used, profit or loss is adjusted for non-cash items, working-capital changes and other relevant items to derive operating cash flow. Depreciation is added back because it reduced accounting profit without being a current-period cash payment, while increases in trade receivables generally reduce operating cash flow because revenue recognised has not yet been collected. The method changes the presentation but not the underlying cash generated.
The cash flow statement reconciles opening and closing cash and cash equivalents, subject to the definition and presentation requirements of the applicable framework. It can therefore reveal whether cash increased or decreased and which categories of activity caused the change. A business might have positive operating cash flow but negative investing cash flow because it is investing heavily in equipment, with the difference funded by borrowing. Another business might show positive total cash flow because it raised substantial debt despite weak operating cash generation. The composition of the cash movement is consequently more informative than the net increase or decrease alone.
Cash flow statements are used to assess liquidity, cash-generation capacity, investment requirements, financing dependence and the sustainability of distributions. Analysts often examine operating cash flow, capital expenditure and free cash flow, although free cash flow is not a single universally defined accounting measure and must be understood according to the formula being used. Working-capital movements can cause significant short-term volatility, so several periods may need to be analysed. Cash flow also needs to be distinguished from profit: a cash inflow from borrowing increases cash but does not constitute revenue, and a repayment of debt reduces cash without being an operating expense in the same sense as wages or utilities.
The cash flow statement has limitations because it reports cash movements rather than the complete economic performance of the business. It does not by itself show whether revenue is profitable, whether assets are productive or whether obligations are sustainable. Timing can also affect cash flows substantially, and some transactions do not involve cash and therefore may be disclosed separately rather than included in the main cash-flow totals.
Nevertheless, together with the balance sheet and income statement, the cash flow statement provides a three-dimensional view of financial position, performance and liquidity. Its central value is showing where cash came from, where it went and how the resulting movement relates to the entity's operating, investing and financing activities.
