There are three main financial statements that all publicly traded companies are required to make available to shareholders: the income statement, the balance sheet, and the cash flow statement. Of the three, the cash flow statement is perhaps the least understood by many investors.
In this article, we’ll go over the basics of a cash flow statement, what information it contains, and how cash flow is calculated. We’ll also walk through a worked example of how you can read and use information from a cash flow statement.
How Cash Flow Statements Work
A cash flow statement is a financial statement that provides details of the flow of money into and out of a business over a period of time. As the name suggests, the main purpose is to show the amount of cash flowing into a business, and this can be very useful when analyzing the financial health of a business.
Note that in business earnings reports, the title of the cash flow statement may be slightly different, for example “Condensed Consolidated Statements of Cash Flows“. But it will always be one of the three main financial statements published by any publicly traded company.
Components of a Cash Flow Statement
Cash flow statements classify the money coming in and going out of a business into three different sections. These are:
- Operating cash flow
- Cash flow from investing activities
- Cash flow from financing activities
Let’s take a look at these one at a time.
Operating cash flow
This part of the cash flow statement contains the cash flow activities directly related to the business activities of the business. It includes the net income generated by the business for the given period and makes some adjustments to more accurately reflect the actual income. For example, depreciation of real estate and equipment is recorded in net income, but it is not an actual expense, so it is added back in the cash flow statement.
This section also contains information about money coming in and going out of the business for items related to its revenue-generating activities. For example, accounts receivable and accounts payable are both included in this section, and any deferred revenue is also accounted for here.
Cash flow from investing
When a company generates money, it usually doesn’t leave it piled up in a warehouse. It takes some of its cash and reinvests it to fuel growth and/or generate income. Some companies buy shares of other companies, some invest in Treasury securities and other fixed income investments, and almost all companies reinvest capital in their own property and equipment needs. All of these things are included in the “investing activities” section of the cash flow statement.
Cash flow from financing
In a nutshell, this category includes cash flows from the company’s stocks and debt. For example, if the company pays a dividend to shareholders or buys back shares, these treasury activities will be included in the financing section. It also includes any debt the company pays off, as well as certain tax payments related to stock awards.
Disclosure of non-monetary activities
This section is also referred to as “supplementary cash flow information”. There are a few things that are not included in any of the other three categories mentioned, especially taxes and interest. If a business pays income taxes or pays interest on its debt, these amounts are generally not included in the cash flow calculation, but are listed in the cash flow statement in a separate section.
How to Calculate Cash Flow
Business cash flow from operating activities, otherwise known as operating cash flow, is the most commonly used measure to describe a company’s “cash flow”. And that certainly makes sense – after all, investing activities like buying treasury bills and fundraising activities like buying back shares have little to do with the financial health of the company itself. As a general rule, cash flow from operations should exceed the bottom line of the business.
There are two methods of calculating a company’s cash flow – the direct and indirect methods. Direct cash flow is simply adding all of a company’s cash transactions into the operating activities section of the cash flow statement. The indirect cash flow method starts with the net income of the business and makes a series of adjustments.
It is important to realize that the method you use will produce the same end result for operating cash flow. It’s also worth noting that cash flow statements typically provide a total of operating cash flow, as you’ll see in the next section.
The other commonly used cash flow measure is known as free movement of capitalwhich is defined as the company’s net cash from operating activities (cash flow from operations) less its capital expenditures, which are listed in the investing activities section.
Free cash flow is an important measure because it shows the company’s free cash generated during the period, which can then be used to reinvest in the company, pay dividends, make acquisitions, buy back shares and for other desirable uses. Some businesses (airlines and oil companies, for example) can be rather capital-intensive, while others don’t require a ton of ongoing capital investment. Thus, free cash flow can provide valuable information about how much of a company’s operating cash flow is actually available for use.
Example of a cash flow statement
To give you a better idea of what a cash flow statement looks like and how to use it in your investment analysis, here is a working example. This is Applethe cash flow statement of (NASDAQ:AAPL) for the first quarter of its fiscal year 2022.
Here are the main takeaways:
Operating cash flow: In the “operating activities” section, you will notice that Apple’s net income for the quarter was approximately $34.6 billion. After making adjustments and accounting for accounts payable and receivable transactions, we find that Apple’s operating cash flow for the quarter was $46.97 billion.
Free movement of capital: In the “Investing Activities” section, you’ll see that Apple spent $2.8 billion on property, plant and equipment (capital expenditures) during the quarter. Subtracting that from operating cash flow, Apple generated $44.17 billion in free cash flow for the quarter. It’s that money that’s allowed it to spend more than $20 billion in stock buybacks, pay out nearly $4 billion in dividends, and more.
One final thought: Although most of the information in the financing, investing, and disclosure sections of the cash flow statement is not used in any of the above calculations, that does not mean that it should be ignored by investors. Cash flow from investing activities can be particularly useful for companies where investments are a particularly important component of the company’s strategy, such as with Berkshire Hathaway (NYSE: BRK.A)(NYSE: BRK.B).
In the financing section, noticing cash flow for dividends and redemptions shows how much a company prioritizes returning capital to investors, and it also lets you know if their dividends and redemptions are well covered by cash. generated by the company.
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Matthew Frankel, CFP® holds positions in Berkshire Hathaway (B shares). The Motley Fool holds and recommends Apple and Berkshire Hathaway (B shares). The Motley Fool recommends the following options: $200 long calls in January 2023 on Berkshire Hathaway (B shares), long $120 calls in March 2023 on Apple, short $200 calls in January 2023 on Berkshire Hathaway (B shares) , short calls of $265 in January 2023 on Berkshire Hathaway (B shares) and short calls of $130 in March 2023 on Apple. The Motley Fool has a disclosure policy.