Cash Flow Statement: A financial report showing how cash moves in and out of a company during a period, split into operating, investing, and financing activities.
What Is a Cash Flow Statement?
Definition:
A cash flow statement (or statement of cash flows) shows how cash moves in and out of a business during a period. It is one of the three core financial statements:
- Income statement → profits (revenues – expenses)
- Balance sheet → assets, liabilities, and equity
- Cash flow statement → actual money in and out
Why it matters:
- Tracks liquidity and bill-paying ability
- Reveals if profits are backed by real cash
- Shows how growth is funded (debt, equity, or internal cash)
- Helps investors assess sustainability
Think of it like your personal bank statement; it shows the truth about cash, not just paper profits.
The 3 Sections of a Cash Flow Statement
1. Operating Activities (OCF)
Begins with net income, adjusted for:
- Non-cash charges (depreciation, amortization)
- Working capital changes (receivables, payables, inventory)
Example:
Net Income = $100,000
+ Depreciation = $20,000
– AR Increase = $15,000
+ AP Increase = $8,000
– Inventory Increase = $12,000
= Operating Cash Flow = $101,000 2. Investing Activities
Cash tied to long-term assets:
- Capital expenditures (CapEx)
- Acquisitions
- Sales of assets
3. Financing Activities
Shows how the business funds itself:
- Borrowing or repaying debt
- Issuing or buying back stock
- Paying dividends
Tip: Growth companies often have negative investing cash flow (CapEx-heavy) but positive financing cash flow (raising funds).
Direct vs Indirect Method
- Indirect method → starts with net income, adjusts for non-cash items (most common).
- Direct method → lists actual inflows/outflows like “cash from customers” and “cash to suppliers” (clearer, less used).
Step-by-Step Example: Building a Cash Flow Statement
RetailCo (small retailer):
- Net Income = $50,000
- Depreciation = $5,000
- – AR Increase = $7,000
- – Inventory Increase = $3,000
- AP Increase = $4,000
Operating Cash Flow = $51,000
- AP Increase = $4,000
Investing = –$15,000
Financing = +$5,000
Net Cash Change = +$41,000
Ending Cash = $51,000
Free Cash Flow & Key Ratios
Formula:
Free Cash Flow (FCF) = Operating Cash Flow – Capital Expenditures
Key Ratios:
- Cash Flow to Debt = OCF ÷ Total Debt
- FCF Margin = FCF ÷ Revenue
- OCF ÷ Net Income = quality of earnings (≥1 = healthy)
Common Pitfalls to Watch Out For
| Pitfall | Why Misleading | What to Check |
|---|---|---|
| Positive net income, negative cash flow | Profits not backed by cash | Compare OCF vs net income |
| One-time asset sales | Inflates cash temporarily | Adjust for recurring OCF |
| Heavy CapEx | Drains cash despite profit | Compare CapEx to depreciation |
Example: Tesla often showed negative free cash flow during growth due to heavy CapEx.
Yes, if profits don’t translate to cash (e.g., receivables growth or debt repayment).
The indirect method is more common in practice because it is easier to prepare from GAAP records.
It could signal cash burn and trouble, or growth investments like CapEx. Context is key.
Under GAAP, dividends paid are in financing activities. Under IFRS, classification can vary.
Investors use free cash flow to build discounted cash flow (DCF) valuation models.
Key Takeaways
- Cash flow statement = shows real money flow, not just paper profits.
- Always check OCF quality vs net income.
- Use FCF to gauge shareholder value.
- Analyze multi-year trends, not single reports.
Author: Max Fonji — The Rich Guy Math
Founder of TheRichGuyMath.com, Max is a financial strategist and personal finance writer with 8+ years of experience studying wealth-building strategies. His mission is to help everyday investors achieve financial independence through data-driven strategies, behavioral finance insights, and real-world case studies.
Disclaimer
This article is for educational purposes only and is not financial advice. Always consult a licensed professional before making financial decisions.
