Cashflow statement

Unlike the profit and loss account, which follows the accruals principal, the cashflow statement records the actual movements in cash in an accounting period. All cash received (inflows) by the company, and spent (outflows) by the company will be shown in this statement.

As determining cash amounts involves less use of judgement and discretion than determining profits or asset value, the cashflow statement is harder to manipulate than the other main accounting statements (the profit & loss account and the balance sheet).

The cashflow statement shows cash coming into a company (from sales, income from investments, asset sales) and going out (payments to suppliers, investment), the raising of capital (money borrowed or raised from shareholders) and the payment of returns of capital (interest and dividends) and tax.

Like profit, cash flow can be measured at a number of levels. For example, operating cash flow roughly corresponds to operating profit with the effects on non-cash items stripped out.

The main items in a typical cash flow statement are (in order):

  • cash flow from operating activities
  • returns on investments and servicing of finance
  • taxation
  • capital expenditure and financial investments
  • acquisitions and disposals
  • equity dividends paid
  • management of liquid resources
  • financing

The returns on investments and servicing of finance includes dividends received (e.g. from subsidiaries) and interest from fixed interest securities and bank deposits. It will also show payments to lenders: both banks and holders of a company's fixed interest securities.

Capital investments and financial investments will show the cashflow relating to the purchase and disposal of fixed assets. Liquid resources are cash and liquid, short term, investments.

All items in the cash flow statement can be significantly different from equivalent items on the P & L. This is what makes the cash flow so valuable (it is not susceptible to manipulation), but it can also make it less meaningful (there are good reasons for accruing in the other accounting statements).

Operating cash flow is very often looked at by investors. The capital expenditure item is a quicker way of finding out how heavily the company is investing than looking at the balance sheet (and then correcting for depreciation etc.) but it has two weaknesses: it does not record purchases not yet paid for and it does not allow one to separate capital expenditure on operating assets from long term financial investments.

A more complex use of the cashflow statement is the calculation of free cash flow, which can be used in valuation ratios and DCF valuations. All the items in the cashflow statement provide a useful check on items in the other accounting statements and are a vital input to the financial models used for forecasting.