A cash flow statement is one of the three core financial statements, alongside the balance sheet and income statement. It provides a transparent picture of how cash enters and leaves a business during a specific period. Unlike profit (which can be affected by accrual accounting adjustments), cash flow shows the actual liquidity position of a company—how much money is available to pay bills, invest, and return capital to shareholders.

For business owners, investors, and financial professionals, analyzing a cash flow statement is essential for evaluating financial health, sustainability, and growth potential.

Highlights of Content

Components of a Cash Flow Statement

A standard cash flow statement is divided into three main categories:

Operating Activities – Day-to-day business cash inflows and outflows.
Investing Activities – Cash used for or generated from investments in assets and securities.
Financing Activities – Cash received from or paid to creditors and investors.

Each section tells a unique story about the financial strategies and performance of a business.

1. Cash Flow from Operating Activities (CFO)

Operating activities measure the cash generated from a company’s core operations.

There are two approaches:

Indirect Method (commonly used)
Direct Method

Examples include:

Cash received from customers
Payments to suppliers and employees
Interest paid and received
Income tax payments

Formula (Indirect Method):

CFO=Net Income+Non Cash Expenses+Changes in Working Capital

Where:

Net Income → from the income statement.
Non-Cash Expenses → depreciation, amortization, provisions.
Changes in Working Capital → (Increase in Current Assets decreases CFO, Increase in Current Liabilities increases CFO).

Example:
If Net Income = $50,000, Depreciation = $5,000, Accounts Receivable (AR) ↑ $10,000, Accounts Payable (AP) ↑ $7,000

CFO=50,000+5,000−10,000+7,000=52,000

Cash Flow from Operations = $52,000

Direct Method formula

CFO=Cash collected from customers+Other operating cash receipts−Cash paid to suppliers−Cash paid to employees−Cash paid for operating expenses−Cash paid for interest−Cash paid for income taxes

2. Cash Flow from Investing Activities (CFI)

Investing activities show how a company spends or earns cash from long-term investments.

Examples include:

Purchase of property, plant, and equipment (PPE)
Sale of assets
Investments in securities or acquisitions

Formula

CFI=Cash Inflows from Sale of Assets + Cash Inflows from Sale of Investments−Cash Outflows for Purchase of Assets−Cash Outflows for Investments

Example:

Purchase of Machinery = ($40,000)
Sale of Equipment = +$20,000

CFI=20,000−40,000=−20,000

3. Cash Flow from Financing Activities (CFF)

Financing activities record transactions with investors and creditors.

Examples include:

Issuance of shares
Dividend payments
Borrowings and repayments

Formula

CFF=Cash Inflows from Issuing Shares + Cash Inflows from Borrowing−Cash Outflows for Loan Repayment−Dividends Paid−Share Buybacks

Example:

Issued Shares = +$15,000
Loan Repayment = ($10,000)
Dividends Paid = ($5,000)

CFF=15,000−10,000−5,000=0

4. Net Change in Cash

Finally, combine all three sections to arrive at the net cash position:

Net Change in Cash=CFO+CFI+CFF

Example:

Net Change in Cash=52,000−20,000+0=32,000

Preparing a Cash Flow Statement

Step 1. Collect financial data

Gather the balance sheet and income statement for the period.

Step 2. Choose a preparation method

Direct Method – Lists all actual cash receipts and payments.
Indirect Method – Adjusts net income for non-cash transactions and working capital changes.

Step 3. Calculate cash flow from operating activities

Use net income and adjust for depreciation, amortization, and working capital changes (indirect method).

Step 4. Calculate cash flow from investing activities

Include purchases and sales of assets and securities.

Step 5. Calculate cash flow from financing activities

Record loan proceeds, repayments, equity issuances, and dividends.

Step 6. Reconcile and validate the cash flow statement

Ensure the Net Cash Flow matches the change in cash on the balance sheet.

Net Cash Flow=Cash from Operations+Cash from Investing+Cash from Financing

Step 7. Review and analyze

Interpret the results to understand the company’s liquidity and strategy.

Direct and Indirect Method

Both methods arrive at the same final cash flow figure, but the presentation differs.

Direct Method

Lists specific cash inflows and outflows, such as:
- Cash received from customers
- Cash paid to suppliers and employees
- Interest and taxes paid
Provides a clearer picture of actual cash movement.
Less common due to detailed tracking requirements.

Example (Direct):

Cash received from customers = $100,000
Cash paid to suppliers = ($60,000)
Cash paid for wages = ($20,000)
Taxes paid = ($5,000)
Net Cash from Operations = $15,000

Indirect Method

Starts with Net Income and adjusts for:
- Non-cash expenses (depreciation, amortization)
- Changes in working capital (receivables, payables, inventory)
More common under GAAP and IFRS.

Example (Indirect):

Net Income = $15,000
Add Depreciation = $2,000
Increase in Accounts Receivable = ($2,000)
Increase in Accounts Payable = $0
Net Cash from Operations = $15,000

Differences Between the Direct and Indirect Method

While both methods ultimately arrive at the same net cash flow from operations, the way they present the information differs significantly. Here’s a detailed comparison:

Aspect	Direct Method	Indirect Method
Approach	Lists actual cash inflows and outflows from operations (cash received from customers, cash paid to suppliers, etc.)	Starts with net income and adjusts for non-cash items (depreciation, amortization) and changes in working capital
Transparency	Highly transparent – shows exact sources and uses of cash	Less transparent – adjustments make it harder for non-experts to follow
Use of Accrual Accounting Adjustments	Minimal – focuses on real cash transactions	Heavy – reconciles accrual-based net income with cash basis
Ease of Preparation	More difficult – requires detailed cash transaction records	Easier – uses information already available from accrual accounting
Regulatory Preference	IFRS and GAAP permit both, but encourage direct method for clarity	GAAP requires indirect method disclosure if direct method is used, making indirect more common
When Generally Used	Rarely used, mostly in smaller companies with simple cash flows or when greater transparency is desired	Widely used by large and public companies due to ease and consistency with financial reporting

Key Insight:

The direct method gives investors and analysts a clearer picture of actual cash movements.
The indirect method is more practical for accountants and regulators, which is why it dominates financial reporting.

Analyzing a Cash Flow Statement

Analysis helps assess if cash generation supports operations, investments, and financing needs.

Key steps include:

Comparing operating cash flow to net income (strong if OCF > Net Income).
Evaluating free cash flow (FCF):

FCF=Operating Cash Flow−Capital Expenditures

Checking debt repayment ability.

Common Indicators and Red Flags

Positive Indicators

Positive OCF: Company generates enough cash from operations.
Negative Investing Cash Flow: Suggests reinvestment in growth.
Stable or Growing FCF: Signals financial health and expansion capacity.

Red Flags

Consistently Negative OCF → Business operations may be unsustainable.
Excessive Financing Inflows → Heavy reliance on debt/equity to stay afloat.
Declining FCF despite rising profits → Possible aggressive accounting or poor cash management.
Large, unexplained changes in working capital → Potential liquidity risks.

Example of a Cash Flow Statement

Here’s a simplified cash flow statement for XYZ Corp (Year 2024):

Operating Activities

Net Income: $50,000
Depreciation: $5,000
Accounts Receivable Increase: ($10,000)
Accounts Payable Increase: $7,000
Net Cash from Operating Activities = $52,000

Investing Activities

Purchase of Machinery: ($40,000)
Sale of Equipment: $20,000
Net Cash from Investing Activities = -$20,000

Financing Activities

Issued Shares: $15,000
Loan Repayment: ($10,000)
Dividends Paid: ($5,000)
Net Cash from Financing Activities = $0

Net Change in Cash = $32,000

Frequently Asked Questions (FAQs)

1. What is the main purpose of a cash flow statement?

The main purpose is to show how cash enters and leaves a business during a period. It helps stakeholders understand liquidity, solvency, and the company’s ability to generate and use cash.

2. What is the difference between OCF, FCF, and Net Income?

Net Income is profit after expenses (accrual-based).
OCF (Operating Cash Flow) is actual cash generated from operations, adjusted for non-cash items and working capital.
FCF (Free Cash Flow) is OCF minus capital expenditures, showing how much cash is truly “free” for investors or debt repayment.

3. Why is an increase in Accounts Receivable (AR) subtracted in OCF?

Because it means more money is tied up in unpaid customer invoices, reducing available cash even though sales increased.

4. Which is better for preparing cash flow statements: Direct or Indirect method?

The indirect method is more common and easier since it starts with Net Income and adjusts for non-cash items.
The direct method provides more transparency but requires detailed cash receipts and payments data.

5. Can a company be profitable but still have negative cash flow?

Yes. A company can report positive Net Income but negative OCF if too much cash is tied up in receivables, inventory, or capital expenditures. That’s why the cash flow statement is crucial.

6. What are common red flags in a cash flow statement?

Consistently negative operating cash flow despite profits.
Heavy reliance on financing activities (borrowing) to stay afloat.
Large increases in AR or inventory without matching cash inflows.
Declining FCF while Net Income looks strong.

7. How does FCF benefit investors?

Free Cash Flow shows how much cash is available for dividends, share buybacks, debt repayment, or reinvestment. Strong and growing FCF usually signals a healthy, investable company.

Final Thoughts

A cash flow statement is more than just numbers — it tells the real story of a company’s financial health. Unlike the income statement, which can be influenced by accounting policies, the cash flow statement shows the actual movement of money.

Operating cash flow (OCF) indicates if the business can sustain itself.
Investing cash flow (CFI) reveals whether the company is reinvesting for growth or selling off assets.
Financing cash flow (CFF) shows how the business funds its operations and growth through debt or equity.
Free Cash Flow (FCF) acts as the ultimate indicator of financial flexibility and shareholder value creation.

For business owners, managers, and investors alike, mastering cash flow analysis means gaining the ability to predict sustainability, spot risks early, and make more informed financial decisions.