In previous posts we understood the Profit/Loss Statement and the Balance Sheet. The third but most important part of the financial statement is Cash Flow Statement (CFS).
In a very simple language cash flow statement is how much cash is entering the company and how much cash is leaving the company.
The CFS allows investors to understand how a company’s operations are running, from which sources the money is coming into the company and how the company is spending that money.
Before we understand the structure of cash flow statement, let’s understand why we need a cash flow statement through the following example which will make things very clear.
Assume there is a shop which sells fruit juice, now all the transactions in that fruit juice shop are done on a cash-to-cash basis i.e. whoever wants to buy a glass of juice has to do payments in form of cash. The daily revenue of fruit juice shop is Rs. 7,000. Now this Rs. 7,000 /- will be go into record books of revenues as Profit and Loss (P&L) per day without any confusion or discrepancy.
Let’s take another example, suppose there is a shop which sells smartphones. For the sake of simplicity, we will assume that the shop sells 10 smartphones daily. However, one day the shop launched a famous smartphone which sold 100 pieces of that smartphone in a single day. The price of each smartphone is Rs. 10,000 /- . Out of those 100 pieces, 70 smartphones were sold on a cash transaction basis that’s is the purchaser paid full cash to the shop owner for each smartphone whereas remaining 30 smartphones were sold at credit that is the purchaser bought the smartphone with a promise to pay later.
Now the total revenue of the shop on that single day for 100 Pieces of smartphones is 100 * Rs. 10,000 = Rs. 10,00,000 /-
But in actuality, the shop owner has the cash of 70 smartphones only that is 70*10,000 = Rs. 7,00,000 /- only while remaining Rs. 3,00,000 /- for 30 smartphones will be paid later.
Even though the smartphone shop made a revenue of 10,00,000/- Rupees which will go into revenue record books as 10,00,000/- however in actual only 7,00,000/- Rupees is present with the shop owner.
This is where the need of Cash Flow statement comes in as it can be effectively used to derive the actual cash that comes into the company and how much actual cash goes out of the company.
The cash flow statement organizes and reports the cash generated and used in the following categories:
- Operating activities – Operating activities reflects cash inflows and outflows generated by core business operations of the company that is how much cash is generated from a company’s products or services. Operating activities include cash activities related to net income by selling or providing services or products to the customers. These are the activities or accounts that we will find in Company’s Income Statement.
For example, cash generated from the sale of goods (revenue) and cash paid for merchandise (expense) are operating activities because revenues and expenses are included in net income.
- Investing activities – This is the amount of cash flow generated by the investments made by the company like equipment or vehicle purchases, or any buildings or property the business owns.
These investment activities are mostly found in the Asset section of the Balance Sheet. It includes cash activities related to non-current assets.
Non-current assets include :
(1) long-term investments;
(2) property, plant, and equipment; and
(3) the principal amount of loans made to other entities.
For example, cash generated from the sale of land and cash paid for an investment in another company are included in this category.
(Note that interest received from loans is included in operating activities.)
- Financing activities – It include cash activities related to all financing activities like taking a loan from bank which will cause increase in cash flows or repaying loan to banks which will cause decrease in cash flows.
Other activities include stock sales and repurchases, dividend payments etc.
(Note that interest paid on long-term debt is included in operating activities.)
Below snapshot shows various activities generating cash flow :
Net Cash Flow of the company = Total cash flow from operating activities + Total Cash flow from investing activities + Total cash flow from financing activities
The cash flow statement differs from the P&L statement and Balance sheet in a way that it does not include the amount of future incoming and outgoing cash which are included in P&L statement and Balance Sheet.
Cash Flow Statement in detail :
Let’s understand the cash flow statement with an example from Hero MotoCorp company.
When we look at the cash flow statement of any company then we are interested in how much cash the company is producing and how much cash the company is spending.
Most Cash Flow Statements consist of three parts:
The first part is Cash flow from Operating Activities : This includes cash generated from operating activities of the company like selling of goods and products.
It also includes cash outflow when the company pays money to its suppliers, distributors etc. which form part of the company’s operations.
Below is Snapshot of Cash flow from Operating activities of Hero MotoCorp Company :
In above snapshot, Total cash generated by Hero MotoCorp from Company’s operations is Rs. 3,913.79 Crores which means there is a Cash Inflow since the amount is positive.
The second segment is Cash flow from Investing Activities : This includes cash generated from Buying and selling of investments made by the company. If Company sell their investments, then they get the cash in return of selling their investments which means there is a cash inflow.
On other hand if Company buys some investment products, then they have to pay money for that investment which means there is a cash outflow.
Below is Snapshot of Cash flow from Investing activities of Hero MotoCorp Company :
In above screenshot, the area marked in green is Cash outflow that is Company has paid cash for buying these investments while rest are cash inflows that is company has got money by selling those investments.
Therefore, Hero MotoCorp has paid cash of Rs. 2,271.34 Crores in investments which means there is a cash outflow since the amount is negative.
The third segment is Cash flow from Financing Activities : This includes cash generated when a company takes a loan or repays a loan taken from banks, when a company gets cash from proceeds of stock issues or payment of principal on debt etc. If a company takes a Loan from banks, then company gets a lot of cash which means there is Cash Inflow.
Similarly, when a company repays a loan then there is a Cash Outflow as they are paying cash to settle the debt.
Below is Snapshot of Cash flow from Financing activities of Hero MotoCorp Company :
When we look at above snapshot, the area marked in Green shows that company has paid cash for financing activities like Interests, Dividends and Taxes which means there is a Cash outflow from the financing activities.
So Hero MotoCorp has used 1,683.95 Crore Rupees as Cash Outflow in FY16 which means there is a cash outflow since the amount is negative.
Summary on Financial Statements :
In last few posts we learnt about the three important aspects of financial statements of the company i.e. the P&L statement, the Balance Sheet and the Cash Flow statement of the company.
The P&L statement shows the revenues and expenditure made by the company. In this we also learned how the earnings of the company also called the surplus of the company and the depreciation amount of P&L statement are added to the balance sheet.
The Balance Sheet provide information on Assets and Liabilities of the company. The main feature of the balance Sheet is to provide an equilibrium on both sides of assets and liabilities i.e. The assets should always be equal to the liabilities, only then we can say that the balance sheet is balanced.
The Cash Flow Statement shows how much cash is entering into the company and how much cash is leaving the company. We also learnt that there are mainly three types of activities used by the company to generate cash flows – Operating activities, Investing activities and Financing activities.