Cash Flow Statement
Cash Flow Statement reports a company’s cash inflows and outflows changes over a period (one year, quarter, month, etc.). This is important because a company must have sufficient cash to pay its expenses and acquire assets. While an Income Statement provides information about whether a company has made a profit, a cash flow statement can provide information about whether the company has generated cash.
The Cash Flow Statement seems like the Income Statement, which shows how much revenue came in and how many expenses went out. The difference lies in a concept called accrual accounting. As discussed in Accrual Accounting and illustrated in “Why Having 3 Financial Statements?“, accrual accounting requires companies to record revenues and expenses when transactions occur, not when cash is exchanged. The principle is known as matching–expenses must match the revenues those expenses created whenever possible. While that explanation seems simple enough, it gets messy in practice, and the statement of cash flows helps investors sort it out.
Let’s do a quick recap here. In layman’s terms, the cash flow statement can be considered as “the linking statement”. Under accrual accounting, earnings and cash flow are two entirely different figures. The earnings figure, the “bottom line” of the income statement, is based on accrual accounting principles. Accrual accounting attempts to reconcile expenses with revenues regardless of when the cash transactions involved in producing the goods sold and receiving the revenue from the sale occurred. Accrual accounting is not solely about when “cash changes hands” This method of accounting requires many interpretations and estimates by management, which may vary from company to company.
For example, higher sales may not translate into higher cash flow if you allow accounts receivable to increase. (Customers may not pay when goods are delivered, but only when invoices are issued). In addition, cash can be used to build up inventories that may lose value or even become obsolete if products are not sold in a timely manner. The expenses to build up these inventories are not recognised until the products are sold. Even the recognition of inventory can vary from company to company, with one company using first-in-first-out (FIFO) accounting and another uses last-in-first-out (LIFO) accounting.
The cash flow statement helps solve many of these problems by providing a link between the income statement and the balance sheet. Think of the cash flow statement like your checking account. Once a transaction occurs and the cash is used, the cash is gone. You do not have to wait for the expense to be recorded over the life of the product purchased. The cash flow statement works the same way: It tells you whether a company was able to generate more cash than it used during the specified period. If the company spent more cash than it was able to bring in, its cash balance decreases. If the cash balance is significantly depleted significantly (or at risk of being significantly depleted), the company must either take on additional debt or sell more shares – both of which can have negative financial consequences.
Cash flow statements are separated into three segments:
- Cash Flows from Operating Activities – Essentially how much profit (or loss) after tax for the period has been realised as cash.
- Cash Flows from Investing Activities – This is cash paid to acquire investments (e.g. PP&E, intangible assets, financial securities) less cash paid from sales of these.
- Cash Flows from Financing Activities – The cash received from issuing debt and equity less cash paid out on redemptions
The following is Cash Flow Statement of Netflix 2021 as example.