Cash Flow Statement

Introduction to Cash Flow Statement

The Cash Flow Statement is the third of the principal accounting tables that form the numerical foundation of an organization's financial report.  Cash flow figures are believed to be harder for a company to manipulate than reported earnings.

Because nearly every transaction involves a transfer of Cash, the Cash Flow Statement can reveal a lot about the inner workings of the business.  Cash flow can even shed light on the quality of the company's earnings. 

Two examples of transaction that provide cash to the company are selling a product at a profit and taking out a bank loan.  Buying new equipment and repaying the loan are transactions that consume the company's cash. 

The Cash Flow Statement lists how much cash was provided to the company, or consumed by the company, during a specified full or partial year by the following categories of transactions:

  • Operations
  • Investing
  • Financing.

If, in the aggregate, more cash is provided to the company than it consumes, then the company's Cash on hand (shown on the Balance Sheet) will increase.  Conversely, when more cash is consumed than provided, the company's cash balance will decrease.

We use the fictional example below to illustrate the construction of the Cash Flow Statement and the information we learn from these statements.

GCFR, Inc. Twelve Months
 (in millions) Ended June 30
  2006 2005
Cash flow from operating activities:    
    Net income $20.1 $17.3
    Adjustments to reconcile net income to cash provided by operating activities:    
    Depreciation and amortization $4.0 $4.9
    Decrease in deferred income taxes ($6.4) ($9.8)
    Stock compensation expense $6.8 $11.6
    Undistributed earnings of affiliated companies ($4.8) ($4.4)
    Gain on sale of business $2.0 $3.6
    Other, net ($7.2) $11.8
Operating cash flow before change in working capital $14.5 $35.0
    Decrease / (Increase) in working capital $15.2 ($12.8)
Cash provided by (used in) operating activities $29.7 $22.2
Cash flow from investing activities:    
    Capital expenditures ($6.5) ($15.8)
    Acquisition of businesses, net of cash acquired ($8.6) ($4.8)
Cash provided by (used in) investing activities ($15.1) ($20.6)
Cash flow from financing activities:    
    Increase in debt $12.0 $19.2
    Decrease in debt ($5.6) ($2.5)
    Dividends paid to shareholders ($8.0) ($7.0)
    Acquisition of treasury stock ($2.0) ($0.8)
    Shares issued under stock plans $0.4 $1.8
Cash provided by (used in) financing activities ($3.2) $10.7
Net increase in cash during the period $11.4 $12.4
    Cash, beginning of period $10.0 $8.0
    Cash, end of period $21.4 $20.4

Cash Flow from (used in) Operations
As can be seen in the table above, the company's Net Income (from the Income Statement) is the starting point for determining how much cash the company's business operations provided or consumed during a particular period.  Net Income has to be adjusted to account for Income Statement gains and expenses, such as depreciation and deferred taxes, that don't result in cash changing hands.  It also has to be adjusted to reflect changes in the company's Working Capital, which is Current Assets - Current Liabilities, because an increase in, say, Inventory or a decrease in Accounts Receivable is due to the movement of cash.

In the example above, Cash Flow from Operations at GCFR, Inc., increased from $22.2 million to $29.7 million.  A 34-percent CFO annual growth rate is very robust.

Cash Flow from (used in) Investing

Investing activities are often a net consumer of cash because most companies, but especially manufacturers, have to make recurring Capital Spending investments to expand and maintain Property, Plant, and Equipment.  Some companies also have cash Acquisition Expenses in certain years.

The sale of investments is a cash-providing activity.

When a company buys equipment that will be used for many years, the cost is booked immediately on the Cash Flow Statement as Capital Spending, but it is charged to operations on the Income Statement as depreciation in installments over the useful life of the equipment.  These installments reduce Net Income each quarter, but they do not result in additional cash flow.

In the example, GCFR invested $15.1 million in cash during the recent period.

Cash Flow from (used in) Financing

Finance activities provide cash when debt securities are issued, and they consume cash when dividends are paid or the company's shares are repurchased from investors.

In the example, GCFR used $3.2 million for financing activities in one year.  These activities provided $10.7 million cash in the previous year.

Net increase (decrease) in cash

In the example, operating activities provided cash of $29.7 million, investing activities consumed $15.1 million, and financing activities consumed $3.2 million.  As a result, GCFR Inc.'s cash balance increased by $11.4 million to $21.4 million.

Free Cash Flow

Free Cash Flow connects the operations and investing sections of the Cash Flow Statement.  FCF, in the sense we use it, is Cash Flow from Operations less Capital Spending. It indicates how much cash the company has left over after paying for the equipment needed to keep the company running.

GCFR, Inc., during the twelve months that ended in June 2006 had Cash Flow from Operations of $29.7 million.  In this period, capital spending was $6.5 million.  Therefore, the Free Cash Flow was $23.2 million.  In the previous year, Free Cash Flow was $22.2 million - $15.8 million = $6.5 million.

GCFR, Inc., had Cash Flow from Operations of $29.7 million in fiscal 2006.  From the Income Statement, we see that it had Revenues of $198.1 million in the same year.

Therefore, CFO/Revenue was 15.0 percent.  During the previous year, the corresponding figures were $22.2 million, $170.0 million, and 13.1 percent.


This is a return on investment measure using FCF instead of Net Income.  With a FCF of $23.2 million, and Stockholders' Equity of $134 million, GCFR's FCF/Equity was 17.3 percent.  For the previous year, the values were $6.5 million, $107 million, and 6.1 percent.

FCF/Invested Capital

This is a broader return on investment measure because Invested Capital reflects the investment made in the company by Equity investors and lenders.

Invested Capital, as we define it, is Capitalization (Shareholders' Equity + Debt), less Cash and Short-term investments.  The subtraction is made because the liquid funds haven't been invested in the company's operations.  The components of Invested Capital can all be found on the company's Balance Sheet.

In our Balance Sheet tutorial, we showed that fictional GCFR Corp. had Invested Capital of

    $134 + ($60 + $9) - $10 - $11 = $182 million

on 30 June 2006. 

With a FCF of $23.2 million, FCF/Invested Capital =12.7 percent

Accrual Ratio

The Accrual Ratio subtracts FCF from Net Income, and divides the result by Total Assets. When FCF is greater than Net Income, the Accrual Ratio is negative, which is good. When Net Income is greater than FCF, it indicates that part of the income was the result of non-cash items (i.e., accruals). Earnings spiked by accruals are considered to be of a lower quality.
For GCFR, Inc., Net Income was $20.1 million and FCF was $23.2 million in fiscal 2006.  FCF exceeded Net Income by $3.1 million. Total Assets were $255 million at the end of the period. The Accrual Ratio was -1.2 percent of assets.

Note: This post was last updated on 23 June 2009.