The Cash Flow Statement (CFS) is a financial statement that reconciles net income based on the actual cash inflows and outflows in a period.
Often used interchangeably with the term, “statement of cash flows,” the cash flow statement tracks the real inflows and outflows of cash from operating, investing and financing activities over a pre-defined period.
Table of Contents
The cash flow statement (CFS), along with the income statement and balance sheet, represent the three core financial statements.
In accounting and finance, the cash flow statement (CFS), or “statement of cash flows,” matters because the financial statement reconciles the shortcomings of the reporting standards established under accrual accounting.
The net income as shown on the income statement – i.e. the accrual-based “bottom line” – can therefore be a misleading depiction of what is actually occurring to the company’s cash and profitability.
Therefore, the statement of cash flows is necessary to reconcile net income to adjust for factors that include the following:
In effect, the real movement of cash during the period in question is captured on the statement of cash flows – which brings attention to operational weaknesses and investments/financing activities that do not appear on the accrual-based income statement.
The impact of non-cash add-backs is relatively straightforward, as these have a net positive impact on cash flows (e.g. tax savings).
However, for changes in net working capital, the following rules apply:
Focusing on net income without looking at the real cash inflows and outflows can be misleading, because accrual-basis profits are easier to manipulate than cash-basis profits. In fact, a company with consistent net profits could potentially even go bankrupt.
The two methods by which cash flow statements (CFS) can be presented are the indirect method and direct method.
Under the indirect method, the format of the cash flow statement (CFS) comprises of three distinct sections.
If the three sections are added together, we arrive at the “Net Change in Cash” for the period.
Net Change in Cash = Cash from Operations + Cash from Investing + Cash from FinancingSubsequently, the net change in cash amount will then be added to the beginning-of-period cash balance to calculate the end-of-period cash balance.
Ending Cash Balance = Beginning Cash Balance + Net Change in CashThe shortcomings regarding the income statement (and accrual accounting) are addressed here by the CFS, which identifies the cash inflows and outflows over a certain time span while utilizing cash accounting – i.e. tracking the cash coming in and out of the company’s operations.
The following is a real world example of a cash flow statement prepared by Apple (NASDAQ: AAPL) prepared under GAAP accrual accounting standards.
Apple Cash Flow Statement Example (Source: AAPL 10-K)
Assuming the beginning and end of period balance sheets are available, the cash flow statement (CFS) could be put together—even if not explicitly provided—as long as the income statement is also available.
We’ll now move to a modeling exercise, which you can access by filling out the form below.
Suppose we are provided with the three financial statements of a company, including two years of financial data for the balance sheet.
The completed statement of cash flows, which we’ll work towards computing throughout our modeling exercise, can be found below.
In Year 1, the income statement consists of the following assumptions.
| Income Statement (P&L) | Year 1 |
|---|---|
| Revenue | $100 million |
| COGS | ($40 million) |
| Gross Profit | $60 million |
| OpEx | ($20 million) |
| D&A | ($10 million) |
| EBIT | $30 million |
| Interest Expense (6%) | ($5 million) |
| Pre-Tax Income (EBT) | $25 million |
| Taxes @ 30% | ($8 million) |
| Net Income | $18 million |
The net income of $18m is the starting line item of the CFS.
In the “Cash from Operations” section, the two adjustments are the:
Next, the only line item in the “Cash from Investing” section is capital expenditures, which in Year 1 is assumed to be:
Likewise, the only “Cash from Financing” line item is the mandatory debt amortization (i.e. required pay down of debt principal):
The beginning cash balance, which we get from the Year 0 balance sheet, is equal to $25m, and we add the net change in cash in Year 1 to calculate the ending cash balance.
Upon adding the $3m net change in cash to the beginning balance of $25m, we calculate $28m as the ending cash.
On the Year 1 balance sheet, the $28m in ending cash that we just calculated on the CFS flows into the current period cash balance account.
For the working capital assets and liabilities, we assumed the YoY balances changed from:
Operating assets declined by $5m while operating liabilities increased by $15m, so the net change in working capital is an increase of $20m – which our CFS calculated and factored into the cash balance calculation.
For our long-term assets, PP&E was $100m in Year 0, so the Year 1 value is calculated by adding Capex to the amount of the prior period PP&E and then subtracting depreciation.
Next, our company’s long-term debt balance was assumed to be $80m, which is decreased by the mandatory debt amortization of $5m.
With the assets and liabilities side of the balance sheet complete, all that remains is the shareholders’ equity side.
The common stock and additional paid-in capital (APIC) line items are not impacted by anything on the CFS, so we just extend the Year 0 amount of $20m to Year 1.
The formula in Year 0 of the retained earnings balance serves as a “plug” for the accounting equation to remain true (i.e. assets = liabilities + equity).
But for Year 1, the retained earnings balance is equal to the prior year’s balance plus net income.
Note that if there were any dividends issued to shareholders, the amount paid out would come out of retained earnings.
In our final step, we can confirm our model is built correctly by checking that both sides of our balance sheet in Year 0 and Year 1 are, in fact, in balance (i.e. Assets = Liabilities + Equity).
Enroll in The Premium Package: Learn Financial Statement Modeling, DCF, M&A, LBO and Comps. The same training program used at top investment banks.
