A Step-by-Step Guide to Read (and Understand) Your Cash Flow Statement

Introduction

Peter Drucker once said, “Entrepreneurs believe that profit is what matters most in a new enterprise. But profit is secondary. Cash flow matters most.” Despite being an invaluable tool to measure financial stability, cash flow often takes a backseat with more emphasis being put on income statements and balance sheets. 

It’s time businesses focus on if they are generating cash well. And that, if it’s enough to cushion their operational expenses while settling their short-term obligations. This is where cash flow statements come in. 

A cash flow statement (CFS) is a measure to identify how well a business is managing their cash position while creating enough reserves to pay debts and operational expenses. It is one of the three financial statements and complements the balance sheet and income statement. 

This blog discusses cash flow statements in great detail. It talks about what a cash flow statement is, its purpose, how to calculate and read it, the limitations and challenges, and finally how technologies help businesses navigate them. 

What is a Cash Flow Statement?

A cash flow statement is one of the three financial statements that determines the inflows and outflows of cash during a given period of time. It highlights the movement of cash within a business’s operating, investing and financing activities. The net cash from these categories is then added up to determine the net increase or decrease in the cash flow. 

The insights derived from a cash flow statement are crucial for constructing accurate cash forecasts and facilitating short-term cash management strategies. Additionally, they help identify revenue-generating prospects and mitigate excessive expenditures, empowering businesses to make well-informed decisions about optimizing operational efficiency. 

Cash flow statements include cash flows from operating, investing and financing activities. Examples of cash flow involve sales revenue and inventory purchases, business purchasing equipment, generating returns on investments, venture capital investments for tech startups or debt repayments, and so on. 

What Is The Purpose Of a Cash Flow Statement?

 Accurate cash flow management is crucial for all businesses, – be it big, profitable enterprises or newly established mid market. When a business doesn’t have a good cash flow, they run into many problems, like the inability to settle short-term loans, lower returns on investments, tied-up working capital, and so on. Creating a cash flow statement is the first step to ensuring robust cash flow management and paving the way for an efficient cash forecasting. 

• Assessing liquidityThe cash flow statement allows stakeholders to evaluate a company’s ability to meet short-term obligations, providing crucial information on financial stability.

• Understanding cash generationCash flow statements provide a 360-degree view of how a company generates cash. Cash flows from operating, investing, and financing activities give a consolidated view of the financial performance of a business.

• Analyzing cash utilizationThe cash flow statement details how a company utilizes its cash resources, enabling stakeholders to evaluate cash management efficiency and potential growth opportunities.

• Identifying financial trendsBy comparing cash flow statements over time, stakeholders can identify trends and patterns in a company’s cash flow dynamics, allowing for an assessment of financial performance and stability.

• Facilitating decision-makingIt gives strategic foresight into a business’s financial strength, helping leaders make informed decisions. It also helps stakeholders evaluate the financial impact of investments and strategic initiatives.

Components Of a Cash Flow Statement

A cash flow statement consists of three components: 

• Cash flow from operating activities Cash flow from operating activities involves cash inflows and outflows due to core business activities like sale of goods, purchase of raw materials, salary and tax payments, etc. It also includes depreciation and amortization, changes in working capital, accounts receivable and payable, etc.

• Cash flow from investing activitiesThis involves cash flows from acquiring and disposing of long-term assets like real estate and other investments that cause changes in capital expenditures (CapEx) but are not included in cash equivalents. The section included plant, property, and equipment (PP&E) purchases , proceeds from PP&E sales, marketable securities, business acquisition proceeds. 

• Cash flow from financing activities This includes cash flows from issuing debt, loan repayment, dividend payments to shareholders, etc. Some examples of financing activities are repurchasing treasury, buy-back shares, proceeds from issuing debts, paying back line of credit, etc. 

How Cash Flow Is Calculated?

There are two ways to calculate cash flow: 

• Direct cash flow approach
• Indirect cash flow approach
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  Direct method Direct method of creating a cash flow statement reports cash inflows and outflows directly reporting from a business’s operating, investing, and financing activities. It can include amounts paid to suppliers, salary payments, and cash from selling products or services. It makes it easier for businesses to see exactly where cash is coming from and going within the business.Let’s take an example. ABC clothing store, selling clothing and accessories, is preparing cash flow using direct methods. And their cash inflows and outflows look like this. 

  
  
  
  
  
  
  
  
  
  
  
  
  
  
  
  
  
  
  
  
  
  
  
  

  Cash Inflows	Amount ($)
  Sales Revenue	$50,000
  Cash from Investments	$2,000
  Loans Received	$10,000
  Total Cash Inflows	$62,000

  
  
  
  
  
  
  
  
  
  
  
  
  
  
  
  
  
  
  
  
  
  
  
  
  
  
  
  
  
  
  
  
  

  Cash Outflows	Amount ($)
  Cost of Goods Sold (COGS)	$20,000
  Operating Expenses	$15,000
  Loan Repayments	$3,000
  Taxes	$5,000
  Investments in Equipment or Expansion	$8,000
  Total Cash Outflows	$51,000

  
  
  
  
  
  
  
  
  

  Net Cash Flow

  $11,000

  
  

  So, ABC Clothing Store had a net positive cash flow of $11,000 in May 2024.

  
  

• Indirect method The indirect cash flow involves using the company’s net income and adjusting it based on non-cash transactions. It is done to reconcile net income to net cash derived from operating activities and identify cash flow implications on accrual adjustments. Non cash expenses include depreciation and working capital changes. Let’s take an indirect cash flow statement example for the same ABC Clothing store. 

  
  

How To Create a Cash Flow Statement

Creating a cash flow statement involves five steps: 

• Identify sources of income
• Add non-cash expenses
• Subtract working capital changes
• Add other cash items
• Calculate cash flow

Cash Flow Statement Example

This consolidated cash flow statement shows the net cash flows for 2021, 2022, and 2023. It highlights the net increase or decrease in cash flows and shows cash flows from operating, investing, financing activities.

Walmart Inc. Consolidated Statements of Cash Flows
(Amount in millions)
Particulars	2023	2022	2021
Cash flows from operating activities:
Consolidated net income	$11,292	$13,940	$13,706
Adjustments to reconcile consolidated net income to net cash provided by operating activities:
Depreciation and amortization	$10,945	$10,658	$11,152
Net unrealized and realized (gains) and losses	$1,683	$2,440	-$8,589
Losses on disposal of business operations	—	$433	$8,401
Deferred income taxes	$449	-$755	$1,911
Loss on extinguishment of debt	—	$2,410	—
Other operating activities	$1,919	$1,652	$1,521
Changes in certain assets and liabilities, net of effects of acquisitions and dispositions:
Receivables, net	$240	-$1,796	-$1,086
Inventories	-$528	-$11,764	-$2,395
Accounts payable	-$1,425	$5,520	$6,966
Accrued liabilities	$4,393	$1,404	$4,623
Accrued income taxes	-$127	$39	-$136
Net cash provided by operating activities	$28,841	$24,181	$36,074
Cash flows from investing activities:
Payments for property and equipment	-$16,857	-$13,106	-$10,264
Proceeds from the disposal of property and equipment	$170	$394	$215
Proceeds from disposal of certain operations, net of divested cash	—	$7,935	$56
Payments for business acquisitions, net of cash acquired	-$740	-$359	-$180
Other investing activities	-$295	-$879	$102
Net cash used in investing activities	-$17,722	-$6,015	-$10,071
Cash flows from financing activities:
Net change in short-term borrowings	-$34	$193	-$324
Proceeds from issuance of long-term debt	$5,041	$6,945	—
Repayments of long-term debt	-$2,689	-$13,010	-$5,382
Premiums paid to extinguish debt	—	-$2,317	—
Dividends paid	-$6,114	-$6,152	-$6,116
Purchase of Company stock	-$9,920	-$9,787	-$2,625
Dividends paid to noncontrolling interest	-$444	-$424	-$434
Purchase of noncontrolling interest	-$827	—	—
Sale of subsidiary stock	$66	$3,239	$140
Other financing activities	-$2,118	-$1,515	-$1,376
Net cash used in financing activities	-$17,039	-$22,828	-$16,117
Effect of exchange rates on cash, cash equivalents and restricted cash	-$73	-$140	$235
Net increase (decrease) in cash, cash equivalents and restricted cash	-$5,993	-$4,802	$10,121
Change in cash and cash equivalents reclassified from (to) assets held for sale	—	$1,848	-$1,848
Cash, cash equivalents and restricted cash at beginning of year	$14,834	$17,788	$9,515
Cash, cash equivalents and restricted cash at end of year	$8,841	$14,834	$17,788

Source

How to Read a Cash Flow Statement

Cash flow statements are usually interpreted on the basis of positive cash flow or a negative cash flow. The ability to read and understand the insights that cash flow statements provide is crucial for businesses to make data-led strategic decisions. 

• Positive cash flowPositive cash flow is when a company generates more money in the business with less expenses over a period of time. It is an ideal situation for a business, as excess cash allows them to reinvest, settle loans, and find better revenue opportunities. However, it is important to note that a positive cash flow does not necessarily mean that a company is profitable. A business can be profitable without having a positive cash flow as well. 

• Negative cash flowNegative cash flow occurs when a business incurs more expenses than generating cash during a period. It generally happens due to a mismatch between expenditures and revenues and does not necessarily translate into lower profits or losses. But businesses must address them and identify the gaps that lead to negative cash flow. 

Sometimes, negative cash flow also occurs when a company decides to expand and invest in future growth. Therefore, it is critical for businesses to analyze the reasons behind the changes in cash flow from one period to the next.

Limitations of A Cash Flow Statement

Here are some of the limitations of a cash flow statement. 

• It ignores non-cash transactionsA cash flow statement excludes non-cash transactions like depreciation, amortization, working capital changes, etc. These non-cash items can significantly impact the financial position of a business when evaluating its overall financial health. 

• Historical data It primarily reflects past cash flows and does not always accurately record current or future financial positions due to timing differences. It provides a summary of cash inflows and outflows over a specific period, which can make assessing overall cash flow management difficult. Moreover, it only focuses on past and present cash flows, ignoring future cash flow expectations. 

• Missing comprehensive analysisA cash flow statement lacks detailed information needed for a comprehensive analysis. It does not note specific sources or uses of cash beyond certain categories which makes it challenging to identify the underlying causes of changes in cash flow. 

• Subjective classificationThe classification of cash flows in a cash flow statement ( operating, investing, and financing activities) is subjective and can vary from one business to another. Different interpretations can result in inconsistencies in how cash flows are classified, making it difficult to compare cash flows across industries. 

Common Cash Flow Challenges to Avoid

Maximizing cash flow is vital for business success, as it serves as the lifeblood of any organization. However, businesses often encounter cash flow challenges like late payments, tied up working capital due to overstocking, lacking expense management, and so on. 

• Late Payments by CustomersLate payments by customers cause a manifold impact on a business’s sustainability. It hampers its ability to repay suppliers, employees, and vendors. To solve this issue, businesses should establish transparent payment terms and diligently follow up with customers who delay payments. Additionally, motivating customers to settle their dues promptly through incentives can ensure smoother cash flow management.

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  Inadequate Planning and BudgetingWithout a clear understanding of cash inflows and outflows, businesses often spend more, failing to detect seasonal fluctuations. To avoid this, businesses should prepare cash flow projections and budgets regularly.

• Inefficient Inventory ManagementInefficient inventory management poses a significant challenge to cash flow. Holding excess inventory can tie up valuable capital and increase storage costs, while inadequate inventory levels lead to stockouts and missed sales opportunities. To overcome this challenge, businesses should implement effective inventory tracking systems and accurate demand forecasting. By monitoring inventory levels and adjusting orders based on demand, businesses can strike a balance that optimizes cash flow.

• Poor Expense ManagementBusinesses may also struggle with poor expense management, including overspending, failing to track expenses, or neglecting to negotiate with vendors. These issues can lead to cash flow gaps and missed opportunities for growth. To avoid this, businesses should track expenses regularly, negotiate with vendors, and implement cost-cutting measures when necessary.

• Market VolatilityMarket conditions, including economic downturns, changes in consumer behavior, or industry disruptions pose numerous roadblocks for businesses. 

• Lack of robust infrastructure that boosts cash flow managementMany businesses still rely on manual and conventional methods to prepare a cash flow statement using spreadsheets rather than implementing technologies like automated cash management tools. Besides making cash flow preparation a time-consuming and error-prone process, the absence of a robust cash flow reporting infrastructure also makes it difficult for leaders to derive key insights and drive strategic decisions that add value to the business. Therefore, businesses must understand which technology and solutions would best suit their complex needs and boost margins. 

  
  

The Power of Automated Cash Flow Management

Businesses can save millions of dollars in staff time every year once they automate their cash flow management. They can substantially speed up the cash management process while improving employee productivity, reporting, and the efficiency of cash projections. Here are some of the significant benefits of implementing automated cash flow management: 

• Easy integration with banks Automated cash management will help businesses integrate with all the major Banks such as BofA, Citi, PNC, Chase, Wells Fargo, HSBC, etc. to automatically gather import bank statements. Finance teams can integrate either using host-to-host via SFTP or use SWIFT connection through partner ie-FIDES. 

• Cash reconciliationWith automated cash management in place, businesses can reconcile cash of prior day planned cash transactions vs bank transactions (ie-Bank statement items). For example, if a company has outstanding checks for $5M, and $3M that were cleared by the bank, then businesses, with the help of this information and cash reconciliation, ensure that $2M does not go out as planned and stays cleared. 

• Debt/Investment managementBusinesses can seamlessly create, track and manage Debt / Investment (D/I) instruments. This often includes bank loans, term loans, letters of credit, etc., in a single place, including intercompany loans or investments. They can also automatically generate cash flows related to D/I instruments and ensure accurate business day information by pulling data like currency depreciations, market holidays, etc. 

• Daily cash positioning Automated cash management also helps businesses create unlimited cash position templates so they can easily analyze global cash visibility by company, bank account, banks, categories, region, countries, dates, etc. It enables finance teams to view the cash positions in a tabular format and quickly identify the bank accounts with low balances and fund them.

How Does HighRadius Transform a Business’s Cash Flow Management?

To redefine automated cash flow management for businesses, HighRadius presents its cutting-edge tool from its Treasury Suite – the cash management software. The state-of-the-art tool not only optimizes cash flows and improves accuracy but also automates daily cash positioning, giving a 360-degree view of cash transactions. It streamlines debt and investment management as well. 

Our cash management software helps businesses with:

• Seamless integration with all banks, ERPs, and independent market data sources to process files in all formats, including XML, BAI2, MT940, ISO 20022, XLS, and CSV.
• Auto-classification of transactions based on bank, account, region, and category and view them in customizable templates.
• Auto-reconciliation of transactions based on standard and user-defined rules without the need for any manual intervention.
• Complete visibility into cash across all banks, regions, companies, and currencies in a unified manner, providing real-time cash positions across bank accounts, companies, pools, and currencies in user-defined worksheet templates.
• Managing general ledger posting rules for bank transactions while it automatically generates GL entries for bank transactions. It also posts GL entries for bank transactions to ERP.

This means businesses will be able to increase their cash management productivity by 70%, along with 100% automated bank integration. 

FAQs

1) What is the difference between direct and indirect cash flow statements?

In a direct cash flow approach, a business directly lists all the major gross cash transactions and payments during a reporting period. The indirect cash flow approach starts with the net income from the income statement and adjusts for changes in balance sheet accounts that affect cash.

2) What is the most important item on a cash flow statement?

The net cash flow from operating activities is the most important item on a cash flow statement. It reflects the cash transactions for a company’s core business operations, providing insights into its ability to generate cash and sustain its operations. It includes the sale of goods, purchase of raw materials, salary and tax payments, etc. 

3) What is a good cash flow ratio?

A good cash flow ratio depends on various factors, such as the industry, the company’s stage of growth, etc. However, a cash flow ratio above 1 is considered to be a good cash flow ratio. It indicates that a company generates enough cash to cover debt payments and financial obligations comfortably.

4) What can a cash flow statement tell you?

A cash flow statement provides insights into a company’s liquidity, operational efficiency, and financial health. It reveals how cash moves in and out of the business over a specific period, showing sources and uses of cash from operating, investing, and financing activities.

5) How much cash flow should a business have?

The ideal cash flow for a business varies. Factors like industry size, growth stage, and financial goals all come into consideration. Generally, a positive cash flow is favorable, as it means that the business generates more cash than it spends and is able to support operational requirements.

6) What are some examples of financing activities?

Financing activities in a cash flow statement usually involves cash transactions from issuing debt, repayments of loans, dividend payments to shareholders, etc. Examples of financing activities include obtaining funds (issuing debt, equity), buying back shares, meeting lease obligations, etc. 

7) What are some examples of cash flow?

Some examples of cash flow include revenue from sales, operational expenses like salaries, investment in assets such as equipment or property, borrowing funds, repayment of loans, reinvesting in stocks, selling marketable securities, dividend distributions to shareholders, etc.

8) Are cash flow statements and cash forecasting the same?

Cash flow forecasts and cash flow statements are different, serving distinct purposes. A cash flow statement records the inflows and outflows of cash in a business throughout the reporting period. Cash forecasting uses the results obtained from cash flow statements to anticipate how a business’ cash flow will perform over time.