Cash Flow Statement

The three sections

A cash flow statement is divided into three buckets:

• Cash flows from operating activities — cash generated or used by running the core business. Starts with net income and adjusts for non-cash items (depreciation, stock-based compensation) and changes in working capital (changes in accounts receivable, accounts payable, inventory).
• Cash flows from investing activities — cash used to acquire or sell long-term assets. Capital expenditures appear here as outflows; proceeds from selling property, equipment, or businesses appear as inflows.
• Cash flows from financing activities — cash from raising or repaying capital. Includes debt issuance and repayment, equity issuance, share buybacks, and dividend payments.

The three sections together must sum to the change in cash on the balance sheet over the period.

Direct vs. indirect method

US GAAP allows two presentation styles:

• Indirect method — starts with net income and adjusts back to cash. Used by nearly all public companies because it's easier to prepare from existing accounting records.
• Direct method — lists actual cash receipts from customers and cash payments to suppliers, employees, and lenders. Conceptually cleaner but rarely used in practice.

Both produce the same total operating cash flow figure; the difference is the level of detail in how it's presented.

What to look for

A few patterns experienced readers check:

• Operating cash flow vs. net income. Healthy companies typically generate operating cash flow that's at least as large as net income, often larger because of depreciation. When operating cash flow lags reported earnings persistently, look harder — it can signal aggressive revenue recognition or working-capital problems.
• Capex intensity. Operating cash flow minus capital expenditures gives free cash flow. Capital-intensive businesses (telecoms, utilities, manufacturers) need most of their operating cash flow just to maintain assets; software companies typically have low capex and high free cash flow conversion.
• Reliance on financing. Companies funding ongoing operations from equity issuance or debt are not yet self-sustaining. Mature businesses typically show negative financing cash flow as they return capital through dividends and buybacks.

Compared to the income statement

The classic example: a fast-growing company can show strong reported profit while burning cash, because revenue is being recognized when earned (sales on credit growing receivables) but cash isn't arriving fast enough to cover ongoing costs. The income statement says "profitable"; the cash flow statement says "running out of money." Both are accurate descriptions of different aspects of the business; both matter.

This is why the cash flow statement was made mandatory in US GAAP in 1987. Before then, companies could go bankrupt while reporting steady profits, and the disconnect was often missed by readers focused on the income statement alone.