A business can be profitable and still run out of cash. The cash flow statement shows why, and it is one of the most useful statements you can learn to read.
Why cash flow matters
The income statement records revenue when it is earned and expenses when they are incurred. Cash moves at different times: customers pay late, suppliers are paid early, equipment is bought upfront. U.S. GAAP (ASC 230) requires a statement of cash flows so users can see where cash came from and where it went.
The three sections
- Operating activities: cash from the day-to-day business, such as receipts from customers and payments to suppliers and employees.
- Investing activities: buying or selling long-term assets such as machinery, property or investments.
- Financing activities: raising or repaying loans, issuing shares and paying dividends.
Operating cash flow can be shown using the direct method (actual receipts and payments) or the indirect method (starting from profit and adjusting). Most companies use the indirect method.
A worked example
| Item | Amount |
|---|---|
| Net profit | 500 |
| Add: depreciation (non-cash) | 100 |
| Less: increase in receivables | (150) |
| Add: increase in payables | 50 |
| Net cash from operating activities | 500 |
| Purchase of equipment (investing) | (300) |
| Loan received (financing) | 200 |
| Net increase in cash | 400 |
Illustrative figures (USD ‘000).
Profit is an opinion. Cash is a fact.
What to look for
- Is operating cash flow positive and broadly in line with profit over time?
- Is growth being funded by the business or by borrowing?
- Are receivables growing faster than sales?
- Is the business spending enough on maintaining its assets?
This article is for general information only and is not professional advice. Please speak to an advisor about your specific situation.