The Balance Sheet tells what a company owns and owes, the income statement tells us what a company earns and pays over the specific timespan. The cash statement uses all that information and explains where the actual money is in all that process.

When thinking about the Cash Statement, it is important to recall the definition of the accrual accounting. Essentially when the revenue is earned and not yet claimed, the revenue is recorded both in the Income Statement (as revenue), and on the Balance Sheet (as receivables, not cash!). At the first sight it feels reasonable to think that we had revenue – we must have more cash! Is that so? – not exactly. The cash has not been impacted yet, and, frankly, the increase in receivables results into a negative cash flow as we are using cash, we have, to finance the delay in receiving cash at some point in the future.

There are three parts of the cash statement:

• Cash Flows from Operations
• Cash Flows from Investing
• Cash Flows from Financing

Cash Flows from Operations

The operational cash is the cash that we have received as we have been operating the business and it all starts with the ‘Net Income’ that we have seen in the previous article at the end of Income Statement. We then subtract and add items that have impacted the use of cash. The formula below calls out three different items that are required for the calculation:

Cash Flow from Operations = Net Income + Non-Cash Items + Changes in Working Capital

While there is not much to highlight in respect to Net Income. Other two items do require additional discussion. The non-cash items include the items that are the expenses that affect the assets rather than cash. Examples of such items are below:

• Depreciation and Amortization
• Unrealized Gain / Loss
• Impairment and Asset Write-Downs
• Stock-based Compensation
• Provision for discount expenses and Future Losses
• Deferred Taxes

Changes in Working Capital are based on the changes of the following items:

• Inventories
• Accounts Payable
• Accounts Receivable
• Accrued Expenses
• Unearned Revenues

As explained earlier the increase in Receivables would be an example of use of cash, equivalently, the decrease in Receivables would lead to increase in cash. Similarly, the increase in inventories would use the cash, while decrease in inventories would lead to freeing up some cash.

Cash flows from Investing

This part of the statement relates to the investments into machinery or buildings as well as the costs related to the mergers and acquisitions activities. This item is directly linked to non-current assets displayed in the Balance Sheet statement.

Cash flow from Investments = Purchase / Sale of Long-term Assets (CAPEX) + Purchase / Sale of Other Businesses (M&S) + Purchase / Sale of Marketable Securities

This part of the cash flow statement is not directly linked to the operational activities, however, is important in determining how much of the cash has been reinvested into the business or taken out of the business operations through divestment.

Cash flows from Financing

The financing part explains how the company is receiving / spending its cash based on the interaction with its investors, either equity or bondholders. The items here are directly linked to the items located on the right side of the Balance Sheet, specifically Liabilities and Owners Equity. The articles on Equity and Bonds are useful to understand these instruments.

The following formula is applied for the calculation of this Cash Flow section:

Cash Flow from Financing = Issue / Repurchase of Equity + Issue / Repurchase of Debt + Dividend Payments / Other Items

Financial Statements Summary

At the end of the Cash Flows statement we can see the sum of the three items mentioned above and the ending cash balance that should reconcile with cash in the balance sheet statement.

As many attentive readers could have noticed, the Cash Statement is linked directly to both Balance Sheet (mainly for cash flows from investing and financing) and Income Statement (mainly for cash flows from operations).

The important lesson here is that all statements are interconnected and together they display a strong summary of the overall company’s health and performance. There are items that are not in scope of these statements, however those are related to the market and competition and cannot be studied in isolation.

Please note, none of the information on this blog represents the opinion of my employer and all information does not represent a financial advice.