What is the Statement of Cash Flows?

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Charles Schwab & Co., Inc.

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What is the Statement of Cash Flows?

Think of cash as the lifeblood of every business. Without cash flow, no business can function—and without an accurate picture of cash flow, no investor can have a complete picture of a company.

A company's statement of cash flows reflects how readily the business can pay its bills, and it provides important information about a company's sources and uses of cash. But measuring cash flow solely from a balance sheet or an income statement is difficult and potentially misleading. That's because not all revenue is received when a company earns it, and not all expenses are paid when incurred.

The difference between an income statement and a statement of cash flows is roughly analogous to the difference between a credit card statement and a checkbook ledger. A credit card statement includes charges that haven't been paid off yet, while an updated checkbook ledger indicates where cash has been spent and whether there's enough to pay off debts like a credit card bill. Similarly, a company's expenses and revenues are recorded on an income statement, regardless of whether cash has changed hands yet. A statement of cash flows, on the other hand, traces where cash came from and where it was used.

The statement also separates cash generated by the normal operations of a company from that gleaned through other investing and financing activities, as seen in the sample statement of cash flows of the hypothetical YYZ Corp.

Statement of cash flows for YYZ Corp. for the year ending Dec. 31, 2003 (in millions)

From operations
Net income	$30
Plus depreciation	15
Plus decrease in receivables (less increase)	(20)
Less increase in inventories	(10)
Plus increase in accounts payable (less decrease)	0
Net increase (decrease) in cash from operations	15
From investing
Less purchase of equipment	(150)
From financing
Bonds issued	100
Net increase (decrease) in cash	(35)
Cash at beginning of year	27
Cash at end of year	$92

Cash flow from operations
Cash flow from operations starts with net income (from the income statement) and adjusts out all of the non-cash items. Income and expenses on the income statement are recorded when a company earns revenue or incurs expenses, not necessarily when cash is received or paid. To figure out how much cash the company received or spent, net income is adjusted for any sales or expenditures made on credit and not yet paid with cash.

Examples of these adjustments are shown above. YYZ had $20 million in sales to customers who had not paid the company as of the end of the year, so this increase in receivables is subtracted. YYZ also reported $15 million in depreciation expense (the portion of long-lasting assets, such as buildings, that is written off each year); depreciation is not a cash item, so it is added back. Finally, YYZ purchased $10 million of additional inventory that was not sold as of year end. Because the inventory wasn't sold, it's not considered an expense. But because cash was used in the purchase, the $10 million is subtracted from net income. Net cash received from YYZ's operations, after the above adjustments, was $15 million.

Cash flow from investing
Cash flow from investing includes cash received from or used for investing activities, such as buying stocks in other companies or purchasing additional property or equipment. YYZ Corp. had no cash receipts from investing in 2003 but spent $150 million to purchase equipment.

Cash flow from financing
Cash flow from financing activities includes cash received from borrowing money or issuing stock and cash spent to repay loans. YYZ Corp. received $100 million in cash from issuing bonds in 2003.

Sizing up operating performance
Of the three main sources of cash flow, analysts look to that from operations as the most important measure of performance. If operations alone don't generate positive cash flow, that may be cause for concern. In addition, a decrease in cash flow due to a sharp increase in inventory or receivables can signal that a company is having trouble selling products or collecting money from customers. However, analysts look at the relative amount of these changes—if accounts receivable have gone up by the same percentage as sales revenues, the increase may not be unusual.

The point of cash flow analysis is to be certain that a company isn't tying up funds in assets that are not generating enough cash flow to meet obligations—so it's an important piece of the financial puzzle.

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The type of securities mentioned may not be suitable for everyone. Each investor needs to review a security transaction for his or her own particular situation. Data contained here is obtained from what are considered reliable sources; however, its accuracy, completeness or reliability cannot be guaranteed.

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