About this lesson
The Cash Flow Statement is a financial report that shows how well the company was able to convert business activity into cash over some time period. This lesson will focus on sources of cash.
Download this lesson’s related exercise files.Cash Flow Statement Part 2.docx
148.4 KB Cash Flow Statement Part 2 - Solution.docx
Cash Flow Statement Part 2
The Cash Flow Statement is a financial report that shows how well the company was able to convert business activity into cash over some time period. This module will focus on sources of cash.
When to Use Cash Flow Statements
Cash Flow Statements are calculated for some time period, typically a month, quarter, or year. It is often used in conjunction with the Earnings Statement and Balance Sheet to ensure a complete picture of financial health of a company.
- The Cash Flow Statement is focused on the generation and use of cash.
- The Cash Flow Statement starts with the Net Income for the time period as calculated on the Earnings Statement.
- The Cash Flow Statement looks at the change in the balance of business accounts over the time period to determine if they reflect a source of cash or a use of cash.
- The Net Cash Flow is added (or subtracted) from the original cash balance at the start of the period to determine the ending cash balance.
- The Cash Flow Statement categorizes the accounts into three categories: Cash from Operating Activities, Cash from Investing Activities, and Cash from Financing Activities.
- Operating Activities can become sources of cash if the business has been able to manage the operation well. This category starts with the Net Income earned during the period.
- Then changes to the amount of money in the operating accounts of Inventory, Accounts Receivable and Accounts Payable can become sources of cash.
- A decrease in Accounts Receivable is a source of cash since the company is collecting cash from customers faster.
- A decrease in Inventory is a source of cash since there is less money needed to buy parts and store them on shelves.
- An increase in Accounts Payable is a source of cash since cash has not been sent to the suppliers.
- Depreciation is added into the Cash from Operating Activities because the Net Income in this category has been decreased by the depreciation charge on the Earnings Statement which represents a portion of the value of investments. Since the cash to purchase the investment has already been accounted for in the Investment portion of the Cash Flow Statement, it must be added back to prevent double counting. More on this when we discuss capitalization and depreciation.
- Investing Activities are seldom a source of cash. The only time this is a source of cash is when an asset that the company invested in has been sold. This could be either a physical asset or a financial asset.
- Financing Activities can be a source of cash. However, as operating managers, we seldom are involved with financing activities. These activities will generate cash in several ways:
- Short-term loan – borrowing money that should be paid back within one year.
- Long-term loan – borrowing money with a term of longer than one year to pay it back – usually from a bank or lending institution.
- Issuing bonds – borrowing money from investors with a commitment to pay it back a certain time.
- Issuing stock (or a percentage of ownership in the company) – receiving money but acquiring additional owners are providing a larger share of the company to an existing owner.
Hints and Tips
- Many companies will subdivide some of these accounts for greater insight.
- Receivables from product sales and receivable from financing product sales.
- Do not confuse cash with profit. You can increase cash and kill the business, or you can show a great deal of profit and run out of cash – especially in an accrual business.
- There are often both sources of cash and uses of cash in each of the three categories.
Lesson notes are only available for subscribers.
PMI, PMP, CAPM and PMBOK are registered marks of the Project Management Institute, Inc.