Cash flow statements are of a recent origin – it was not available to us in the 1980s – and we had to create it ourselves.

It is a statement which shows the inflow and outflow of cash – for a particular period of time (like the Profit and Loss account). It shows you how the company managed its liquidity. It shows how profitable the operations were and how did it fund its expansion and its day to day operations. This is important because a company needs to have enough cash on hand to pay its expenses and purchase assets. While the Profit and Loss statement tells you whether a company made a profit, a cash flow statement can tell you whether the company earned (and collected!) cash.

A cash flow statement (like the PnL) shows changes over time – unlike the balance sheet which shows the numbers absolute rupee amounts at a point in time. It is drawn from the profit and loss account and the changes in the balance sheet.

At the end of the year if a company has a lot of cash, is it a good sign or a bad sign? No. It is not possible to answer this question UNLESS you know whether this was caused by better operations, by borrowing, or by selling off an asset, right? So the cash flow statement tells you that. The bottom line of the cash flow statement shows the net increase or decrease in cash for the period. Generally, cash flow statements are divided into three main parts.

Each part reviews the cash flow from one of three types of activities:

(1) operating activities (CFO)

(2) investing activities (CFI)

and (3) financing activities (CFF).

Operating Activities

The first part of a cash flow statement enumerates company’s cash flow from net income or losses that it has made. For most companies, this section of the cash flow statement reconciles the net income (as shown on the income statement) to the actual cash the company received from or used in its operating activities. To do this, it adjusts net income for any non-cash items (such as adding back depreciation expenses and ammortisation expenses).

Investing Activities

The second part of a cash flow statement shows the cash flow from all investing activities. This means the money spent or realized from purchases or sales of long-term assets, such as property, plant and equipment, as well as investments. If a company buys an asset, the cash flow statement would reflect this activity as a cash outflow from investing activities because it used cash. If the company decided to sell off some investments from an investment portfolio, the proceeds from the sales would show up as a cash inflow from investing activities because it provided cash. Simple?

Financing Activities

The third part of a cash flow statement shows the cash flow from all financing activities. Typical sources of cash flow include cash raised by placing shares and/ or bonds or borrowing from banks. Likewise, paying back a bank loan would show up as a use of cash flow.