Operating Cash Flow

The cash flow statement begins with Cash Flow from Operating Activities. It starts with net income or loss, followed by additions to or subtractions from that amount to adjust the net income to a total cash flow figure. What is added or subtracted are changes in the account balances of items found in current assets and current liabilities on the balance sheet, as well as non-cash accounts (e.g., stock-based compensation). We then arrive at the cash version of a company’s net income.

Net Earnings

This amount is the bottom line of an income statement. Net income or earnings shows the profitability of a company over a period of time. It is calculated by taking total revenues and subtracting from them the COGS and total expenses, which includes SG&A, Depreciation and Amortization, interest, etc.

Plus: Depreciation and Amortization (D&A)

The value of various assets declines over time when used in a business. As a result, D&A are expenses that allocate the cost of an asset over its useful life. Depreciation involves tangible assets such as buildings, machinery, and equipment, whereas amortization involves intangible assets such as patents, copyrights, goodwill, and software. D&A reduces net income in the income statement. However, we add this back into the cash flow statement to adjust net income because these are non-cash expenses. In other words, no cash transactions are involved.

Less: Changes in working capital

Working capital represents the difference between a company’s current assets and current liabilities. Any changes in current assets (other than cash) and current liabilities affect the cash balance in operating activities.

For instance, when a company buys more inventory, current assets increase. This positive change in inventory is subtracted from net income because it is seen as a cash outflow. It’s the same case for accounts receivable. When it increases, it means the company sold their goods on credit. There was no cash transaction, so accounts receivable is also subtracted from net income. On the other hand, if a current liability item such as accounts payable increases, this is considered a cash inflow because the company has more cash to keep in its business. This is then added to net income.

Cash from operations

When all the adjustments have been made, we arrive at the net cash provided by the company’s operating activities. This is not a replacement for net income, but rather a summary of how much cash is generated from the company’s core business.

Investing Cash Flow

This category on the statement of cash flows is referred to as Cash Flow from Investing Activities and reports changes in capital expenditures (CapEx) and long-term investments. CapExcan refer to the purchase of property, plant, or equipment assets. Long-term investments may include debt and equity instruments of other companies. Another important item found here is acquisitions of other businesses. A key to remember is that a change in the long-term assets in the balance sheet is reported in the investing activities of the cash flow statement.

Investments in Property and Equipment

These CapEx investments might mean purchases of new office equipment such as computers and printers for a growing number of employees, or the purchase of new land and a building to house business operations and logistics of the company. These items are necessary to keep the company running. These investments are a cash outflow, and therefore will have a negative impact when we calculate the net increase in cash from all activities. Learn how to calculate CapEx with the CapEx formula.

Cash from investing

This is the total amount of cash provided by (used in) investing activities.

Financing Cash Flow

This category is also called Cash Flow from Financing Activities and reports any issuance or repurchases of stocks and bonds of the company, as well as any dividend payments it makes. The changes in long-term liabilities and stockholders’ equity in the balance sheet are reported in financing activities.

Issuance (repayment) of debt

A company issues debt as a way to finance its operations. The more cash it has, the better, as it will be able to expand rapidly. Unlike equity, issuing debt doesn’t grant any ownership interest in the company, so it doesn’t dilute the ownership of existing shareholders. The issuance of debt is a cash inflow, because a company finds investors willing to act as lenders. However, when these investors are paid back, then the debt repayment is a cash outflow.

Issuance (repayment) of equity

This is another way of financing a company’s operations. Unlike debt, equity holders have some ownership stake in the business in exchange for money given to the company for use. Future earnings must be shared with these equity holders or investors. Issuance of equity is an additional source of cash, so it’s a cash inflow. Conversely, an equity repayment is a cash outflow. This is buying back, through cash payment, the equity from its investors and thereby increasing the stake held by the company itself.

Cash from financing

This is also called the net cash provided by (used in) financing activities. The cash from financing is calculated by summing up all the cash inflows and outflows related to changes in long-term liabilities and shareholders’ equity accounts.

Cash Balance

The last section on the statement of cash flows is a reconciliation of the total cash position, which connects to the balance sheet. This is the final piece of the puzzle when linking the three financial statements.

Net Increase (decrease) in Cash and Closing Cash Balance

Once we have all net cash balances for each of the three sections of the cash flow statement, we sum them all up to find the net cash increase or decrease for the given time period. We then take this amount and add it to the opening cash balance to eventually arrive at the closing cash balance. This amount will be reported in the balance sheet statement under the current asset section.

Opening cash balance

The opening cash balance is last year’s closing cash balance. We can find this amount from last year’s cash flow statement and balance sheet statement.