Cash flow statement. – An introduction.


The Cash flow statement is the final component of a company’s annual report. It throws light on the cash generating ability of a company. The statement records the actual movements in cash in an accounting period. All cash received (inflows) by the company, and spent (outflows) by the company will be shown in this statement.

Cash flow statements may be a little bit difficult to understand than balance sheets and income statements.


If you recall our article on matching principle, you’d have understood that the expenses and revenues shown in the income statement are subject to lot of adjustment. Accountants do not consider the actual payment or receipt of cash and instead, follows the matching concept. hence, it would be impossible for anyone who analyses the company’s financial statement to know the exact inflow and outflow of cash. for this, we need the help of a cash flow statement.

CFS ( Cash flow statements ) shows the liquidity and solvency position of a company. It throws light on the ability of the company to generate cash from its core operations, and where from it sources funds for expansion. The CFS discloses the actual movement of cash. Hence, it is also a useful tool to gauge a company’s ability to effectively manage cash. For example, while profit figures may not help a bank to analyse the loan repaying capacity of the company,  an analysis of the cash flows will provide information on the funds available for the same.


Cash flows are classified under three heads — operating, financing  and investing activities. The first two sections show the two ways the company can get cash. Operations means “making” money by selling goods and services; Financing means “raising” money by issuing stocks and bonds. The third section shows how the company is spending cash, Investing in its future growth. If you’re interested in the stock of this company, you’d like to see that they can pay for the “investing” figure out of the “operations” figure, without having to turn to “financing”. (Financing causes problems: issuing new stocks will lower the value of each individual share; issuing bonds commits them to making interest payments which will punish future earnings)

Actual cash flows differ from profits. A company may be low on cash but reported good earnings and vice-versa. The CFS explains the reason for this divergence. Consider this case. A company that has sold its goods on credit (shown  as sundry debtors in balance sheet ) may take time or have trouble realizing the cash. This may elongate the company’s working capital cycle and force it to resort to other funding options to keep the production cycle moving. Similarly, a company may have produced goods but piled them up as inventory without quickly converting them into revenues.

Here the cost of holding such inventory instead of converting it into cash would affect operations. Both these may also be indicators of a slowing demand (in case of inventory build up) or higher risk of debtors becoming bad. Thus, a study of operating cash flows may be a key indicator of a company’s health or provide cues for any impending trouble in its business or financial position.

In our next two lessons, we try to understand cash flow statements from the investor’s point of view and will also give tips to analyse cash. We will also look at how to analyse cash flow without actually looking at a cash flow statement which is a bit complicated to read.

You may like these posts:

  1. The Income statement : Basics
  2. The Income statement : Understanding the “matching principle”.
  3. The Income statement: Understanding the components.

1 Response to “Cash flow statement. – An introduction.”

Thejas Krishna

August 19, 2016 at 12:58 pm

Simply understandable and easy to study the Cash flow Statements,Thanks.

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