Financial statements course · Lesson 4 of 10
The cash flow statement shows where the cash went.
Profit is an accounting figure. Cash is a fact. The cash flow statement shows how the profit turned into cash, and where that cash went.
The statement
| Line | $ millions |
|---|---|
| Net income | 137.5 |
| Depreciation and amortization | 40.0 |
| Stock pay | 15.0 |
| Change in receivables | (8.9) |
| Change in inventory | (6.7) |
| Change in payables | 4.4 |
| Change in accrued expenses | 2.2 |
| Change in deferred revenue | 1.5 |
| Cash from operations | 185.1 |
| Capital expenditure | (80.0) |
| Cash used in investing | (80.0) |
| Dividends | (40.0) |
| Buybacks | (30.0) |
| Cash used in financing | (70.0) |
| Change in cash | 35.1 |
| Cash, start of year | 114.9 |
| Cash, end of year | 150.0 |
The statement has three sections.
- Operating activities: the cash from the business itself.
- Investing activities: the cash spent on equipment and acquisitions, or received from sales of assets.
- Financing activities: the cash from lenders and shareholders, or paid to them.
Why it starts with net income
Most companies use the indirect method. The statement starts with net income and then corrects it in two steps.
First, it adds back the costs that used no cash. Depreciation of $40 million spreads the cost of old equipment over its life. Stock pay of $15 million is paid in shares. Neither one took cash out this year.
Then it corrects for working capital. Receivables and inventory grew, and that growth used cash. Payables, accrued expenses and deferred revenue grew too, and that growth gave cash. The net effect was -$7.4 million.
Cash from operations against net income
Example Co. made $1.35 of cash from operations for each $1 of net income. A ratio above 1 is normal for a company that adds back depreciation and stock pay. Lesson 9 shows a company where the ratio is below 1, and why that is a warning.
Cash from operations, less capital expenditure, is free cash flow: $105.1 million. Example Co. paid $70 million of it to its owners and kept the rest. Cash grew by $35.1 million.
Key points
- Three sections: operating, investing and financing.
- The statement starts with net income and corrects it to cash.
- Compare cash from operations with net income each year.
Sources
- SEC, Beginners’ Guide to Financial Statements, for the balance sheet equation, current items, the three sections of the cash flow statement and the statement of shareholders’ equity.