Understanding Cash Flow Statements

A cash flow statement is a financial statement used by businesses to analyze their past transactions with respect to cash receipts from customers, payments made to suppliers, and other changes affecting its bank account balance. This document helps investors understand how much money comes into and out of a company's accounts over time, providing crucial information on whether a business generates enough funds from operations to pay its debts when they come due, make new investments, or return excess capital to shareholders through dividends. There are two main methods for preparing a cash flow statement: the indirect method and the direct method.

The indirect method, also known as the operating cash flows approach, involves calculating net income and adjusting it to arrive at a figure representing cash generated by the firm during a specific period. In this method, items such as depreciation, amortization, deferred taxes, etc., which appear in the accrual basis of accounting but do not involve actual transfer of cash, need to be adjusted so that only cash amounts remain. For instance, depreciation expense would be eliminated because it does not reflect any cash outflow from the sale of assets despite appearing under expenses.

In contrast, the direct method records all major sources of revenue and expense directly without using net income. It involves listing different categories of cash inflows including collections from sales, interest earned on investments, and non-operational gains like selling of fixed assets, alongside listings of cash outflows including payments towards supplies, wages and salaries, tax payments, etc.. Both these methods can yield similar results since the final outcome depends upon how well one has recorded each step involved.

Two key sections in the cash flow statement are financing activities and investing activities. Financing activities represent borrowing and repayment actions along with issuance or retirement of stock. Investing activities cover purchases of property, plant, equipment, intangible assets and securities. Operating activities include the day-to-day trading activities like buying and selling goods or services to clients and paying employees.

A cash flow statement presents important aspects of a company's performance as seen from the perspective of its creditors and shareholders. These analyses help in understanding where the money is coming from, what it's being spent on, and if there might be issues with liquidity, profitability, or solvency. By examining this report closely, you'll have better insight into a company's future plans regarding expansion and payouts, among others.