Analysis Using the Statement of Cash Flows
This chapter explains the purposes and uses of the statement of cash flows and where items appear on it, and describes how to calculate operating cash flows under the direct and indirect methods. It covers preparing the statement across operating, investing, and financing activities, and analyzing results with cash flow per share and margin.
Purpose and content of the statement of cash flows
The statement of cash flows reports the cash a company generated and used during a period, classified into operating, investing, and financing activities, and reconciles the change in cash from the beginning to the end of that period. It supplements the income statement and balance sheet by showing where cash actually came from and where it went, which matters because a profitable company can still face a cash shortage if its earnings are not backed by cash.
The direct and indirect methods
Cash flows from operating activities can be calculated under the direct method, which lists actual cash receipts and payments such as cash collected from customers and cash paid to suppliers, or under the indirect method, which starts from net income and adjusts it for noncash items and changes in working capital accounts to arrive at the same operating cash flow figure. Both methods produce identical totals for investing and financing activities; they differ only in how the operating section is presented.
Analyzing cash flow results
Once prepared, a statement of cash flows can be analyzed using ratios such as cash flow per share of common stock, cash flow margin, which relates operating cash flow to sales, and cash flow liquidity ratios, which compare cash resources to current obligations. Applied to a real company’s statement, these measures help assess whether reported earnings are supported by actual cash generation rather than by accounting estimates alone.