The cash flow statement (CFS) statement (CFS), a mandatory part of a company’s financial reports since 1987, records the amounts of cash and cash equivalents entering and leaving a company. The CFS allows investors to understand how a company’s operations are running, where its money is coming from, and how it is being spent.
Cash flow is determined by looking at three components by which cash enters and leaves a company: core operations, investing and financing.
Measuring the cash inflows and outflows caused by core business operations, the operations component of cash flow reflects how much cash is generated from a company’s products or services. Generally, changes made in cash, accounts receivable, depreciation, inventory and accounts payable, are reflected in cash from operations.
Changes in accounts receivable on the balance sheet from one accounting period to the next must also be reflected in cash flow. If accounts receivable decreases, this implies that more cash has entered the company from customers paying off their credit accounts – the amount by which AR has decreased is then added to net sales.
If accounts receivable increase from one accounting period to the next, the amount of the increase must be deducted from net sales because, although the amounts represented in AR are revenue, they are not cash.
An increase in inventory, on the other hand, signals that a company has spent more money to purchase more raw materials.
If the inventory was paid with cash, the increase in the value of inventory is deducted from net sales. A decrease in inventory would be added to net sales.
And If inventory was purchased on credit, an increase in accounts payable would occur on the balance sheet, and the amount of the increase from one year to the other would be added to net sales.
Changes in equipment, assets or investments relate to cash from investing. Usually cash changes from investing are a “cash out” item, because cash is used to buy new equipment, buildings or short-term assets such as marketable securities.
However, when a company divests of an asset, the transaction is considered “cash in” for calculating cash from investing.
Changes in debt, loans or dividends are accounted for in cash from financing. Changes in cash from financing are “cash in” when capital is raised, and they’re “cash out” when dividends are paid.
Thus, if a company issues a bond to the public, the company receives cash financing; however, when interest is paid to bondholders, the company is reducing its cash.