Cash Flow Statement Structure#

The cash flow statement tracks where cash comes from and where it goes. While the income statement can be influenced by accounting choices, cash is objective—you either have it or you don't.

Cash is king. A company can report profits and still go bankrupt if it runs out of cash. The cash flow statement shows whether profits are turning into real money.

Why Cash Flow Matters#

The Profit vs. Cash Problem#

Consider this scenario:

Company reports $10 million net income (looks great!)
But customers haven't paid yet ($8 million in receivables)
Inventory increased by $5 million (cash tied up)
Actual cash from operations: negative $3 million

This company is profitable on paper but burning cash. Without the cash flow statement, you'd miss this critical warning sign.

What Cash Flow Reveals#

Question	What to Check
Are profits real?	Does operating cash flow match net income?
Is the company growing?	What's being invested in capex?
How is growth funded?	Debt, equity, or internal cash?
Can dividends continue?	Is there enough cash to pay dividends?

The Three Sections#

The cash flow statement divides cash movements into three categories:

CASH FLOW STATEMENT

Operating Activities
├── Net Income
├── + Non-cash expenses (depreciation, etc.)
├── +/- Working capital changes
└── = Cash from Operations

Investing Activities
├── Capital expenditures (negative)
├── Acquisitions (negative)
├── Asset sales (positive)
└── = Cash from Investing

Financing Activities
├── Debt borrowed/repaid
├── Stock issued/repurchased
├── Dividends paid
└── = Cash from Financing

Net Change in Cash
Beginning Cash Balance
= Ending Cash Balance

1. Operating Activities#

Cash generated from running the core business:

Cash collected from customers
Cash paid to suppliers and employees
Interest and taxes paid

This is the most important section. A healthy business should generate positive operating cash flow.

2. Investing Activities#

Cash used for long-term investments:

Buying property, equipment (capital expenditures)
Acquiring other companies
Selling assets or investments

Usually negative for growing companies (they're investing in the future).

3. Financing Activities#

Cash from investors and creditors:

Borrowing or repaying debt
Issuing or buying back stock
Paying dividends

Depends on strategy—growing companies raise capital; mature companies return it.

Typical Cash Flow Patterns#

Company Stage	Operating	Investing	Financing
Startup	Negative	Negative	Positive
Growing	Positive	Negative	Positive or Negative
Mature	Positive	Negative	Negative
Declining	Positive declining	Positive (selling assets)	Negative

Quick Health Check

The ideal pattern: Strong positive operating cash flow funding both investments (negative investing) and shareholder returns (negative financing). This means the business generates enough cash internally to fund growth AND return money to shareholders.

The Indirect Method#

Most companies use the "indirect method" for the operating section, which starts with net income and adjusts:

Why Adjustments Are Needed#

Net income uses accrual accounting, but the cash flow statement needs actual cash. The adjustments convert accrual to cash:

Adjustment	Why It's Needed
Add: Depreciation	Depreciation reduced net income but didn't use cash
Add: Increase in payables	Expenses recorded but not yet paid
Subtract: Increase in receivables	Revenue recorded but not yet collected
Subtract: Increase in inventory	Cash spent on inventory not yet sold

Example Reconciliation#

Item	Amount
Net Income	$100,000
Add: Depreciation	$20,000
Add: Increase in Payables	$5,000
Subtract: Increase in Receivables	($15,000)
Subtract: Increase in Inventory	($25,000)
Cash from Operations	$85,000

Even though net income was $100,000, actual cash generated was $85,000 due to working capital changes.

Connecting to Other Statements#

The cash flow statement links the income statement and balance sheet:

Connection	How It Works
Net income	Starting point for operating cash flow (from income statement)
Depreciation	Added back (appears on both income statement and balance sheet)
Working capital changes	Balance sheet changes become cash flow adjustments
Ending cash	Must match cash on the balance sheet

The ending cash balance on the cash flow statement should exactly equal the cash shown on the balance sheet. This is a key check that the statements tie together properly.

What to Look For#

Positive Signs#

Operating cash flow > Net income (high quality earnings)
Growing operating cash flow over time
Self-funding growth (operating cash covers investing needs)
Consistent cash generation through economic cycles

Warning Signs#

Operating cash flow < Net income persistently (low quality earnings)
Positive net income but negative operating cash flow
Relying heavily on financing to fund operations
Erratic cash flows that don't match business performance

The Ultimate Test

If a company consistently reports profits but can't generate operating cash flow, something is wrong. Either the earnings are low quality, or there's a fundamental business problem.

Key Takeaways

The cash flow statement shows actual cash in and out
Three sections: Operating, Investing, and Financing
Operating cash flow is the most important—it should be positive for healthy businesses
The indirect method starts with net income and adjusts for non-cash items
Cash flow links the income statement to the balance sheet
Compare operating cash flow to net income to assess earnings quality