Operating Cash Flow
Operating activities are the principal revenue-producing activities of the entity. Cash Flow from Operations typically includes the cash flows associated with sales, purchases, and other expenses.
The company’s chief financial officer (CFO) chooses between the direct and indirect presentation of operating cash flow:
- Direct Presentation: Operating cash flows are presented as a list of cash flows; cash in from sales, cash out for capital expenditures, etc. This is a simple but rarely used method, as the indirect presentation is more common.
- Indirect Presentation: Operating cash flows are presented as a reconciliation from profit to cash flow:
| Profit | P |
| Depreciation | D |
| Amortization | A |
| Impairment expense | I |
| Change in working capital | ΔWC |
| Change in provisions | ΔP |
| Interest Tax | (I) |
| Tax | (T) |
| Operating cash flow | OCF |
The items in the cash flow statement are not all actual cash flows, but “reasons why cash flow is different from profit.”
Depreciation expense reduces profit but does not impact cash flow (it is a non-cash expense). Hence, it is added back. Similarly, if the starting point profit is above interest and tax in the income statement, then interest and tax cash flows will need to be deducted if they are to be treated as operating cash flows. There is no specific guidance on which profit amount should be used in the reconciliation. Different companies use operating profit, profit before tax, profit after tax, or net income. Clearly, the exact starting point for the reconciliation will determine the exact adjustments made to get down to an operating cash flow number.
Investing Cash Flow
Cash Flow from Investing Activities includes the acquisition and disposal of non-current assets and other investments not included in cash equivalents. Investing cash flows typically include the cash flows associated with buying or selling property, plant, and equipment (PP&E), other non-current assets, and other financial assets. Cash spent on purchasing PP&E is called capital expenditures.
Financing Cash Flow
Cash Flow from Financing Activities are activities that result in changes in the size and composition of the equity capital or borrowings of the entity. Financing cash flows typically include cash flows associated with borrowing and repaying bank loans, and issuing and buying back shares. The payment of a dividend is also treated as a financing cash flow.