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The Cash Flow Statement - Part III
An exampleThis is company A's first year in business. The company ended the year with revenue of $200,000. Of this amount, payment was received for only $35,000. The balance of $165,000 is shown on the balance sheet as Accounts Receivable.
The company incurred expenses of $120,000 during the year. Of the total expenses, the following is true:
- Non-cash charges - Depreciation $15,000
- Expenses on which credit was received - $105,000
Total Revenue $200,000Less expenses $120,000Net Income $80,000 |
Of the $80,000 in net income, Company A has only $35,000 in cash. Why is that? This may be illustrated using the cash flow statement. The statement below is based on the information we have about Company A's trading activities:
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STATEMENTS OF CASH FLOWS (Abridged) Net Income $80,000Add back non-cash charges $15,000Funds Flow $95,000 Changes in working capitalIncrease in Accts Receivable -$165,000Increase in Accts Payable $105,000Cash inflow to company A $35,000 |
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The example above provides a simple introduction to preparing the cash flow statement. There are a few things to note before you go on:
- The actual excess of revenue over cost is $105,000, which is total expenses ($120,000) less depreciation ($15,000).
- The increase in Accounts Receivable is deducted from Funds Flow
- The increase in Accounts Payable is added to Funds Flow
- Increase in assets - Outflow/Use of funds
- Increase in liabilities - Inflow/Source of funds
- Decrease in assets - Inflow/Source of funds
- Decrease in liabilities - Outflow/Use of funds
Similarly, our assumption regarding Accounts Payable was that A/P was zero at the beginning of the year and $105,000 at the end. The increase in A/P is then included on the cash flow statement as a Source of fund (added to net income).
Finally, to see how we moved from a revenue position of $200,000 to cash in hand of $35,000, we will follow the money trail:
- Company A purchased $105,000 in inventory. How did it pay for this and still end up with $35,000 in cash? The answer is that Company A has not paid for the inventory. This $105,000 is still owed to suppliers. This is shown as the increase in Accounts Payable in the Cash Flow Statement.
- Of the $200,000 in revenue, Company A's customers are holding onto $165,000. This is shown on the Cash Flow Statement as the increase in Accounts Receivable. The full amount of cash collected from customers is $35,000 and this is the only cash that Company A has, and this is what is shown on the Cash Flow Statement as Cash Inflow (see above).
The Cash Flow from Investing and Financing sections
The remaining portion of the Cash Flow Statement is divided between the Investing and Financing sections. These sections are not as academically demanding as the Cash Flow from Operating section, but they are very important to a full understanding of the company's cash inflow and outflow.
"Investing activities" as used in the Cash Flow Statement refers to the investments made by management and includes both losses and gains from those investments. This section displays:
- Cash flows from acquiring and disposing short-term investments other than cash equivalents.
- Cash flows from acquiring and disposing fixed assets.
- Cash flow related to new issue of stock (common or preferred)
- Loan proceeds or payments
- Dividends payments as well.
Free Cash Flow:
Free Cash Flow is a performance indicator that has taken on significance in recent time. The company's Free Cash Flow is calculated by taking Total Capital Expenditure from Cash Flow from Operations:
Capital Expenditure (investment in plant, equipment, property and other similar assets) is usually the first item listed in the Cash Flow from Investing activities section of the Cash Flow Statement, making Free Cash Flow calculation easy to accomplish while reviewing the Cash Flow Statement.
Free Cash Flow has gained the attention of investors and analysis because it reflects the cash available to the company for "free" or discretionary spending. Capital expenditure is required spending by the company to maintain/improve its present stock of assets in a competitive environment and a company's ability to generate cash in excess of this amount is considered bonus.
Free Cash Flow gives a company the cash resources to do things such as pay dividends, pay down debts, purchase new businesses etc., so the next time you review the Cash Flow Statement, take a few minutes to analyze free cash flow; it could be the difference between a good decision and a very good decision!
Go to: Cash Flow Part 1
Go To: Cash Flow - part 2
More On Cash Flow
Free Cash Flow therefore implies positive cash flow from operations. From this the company will spend on new capital equipment (or upgrade on old equipment) necessary to maintain the present and future success of the company. The balance remaining is the Free Cash Flow.
Free Cash Flow formula:
Cash flow from operations less capital expenditure
Burn Rate:
This is another of those cash flow related terms used on a regular basis by the great financial minds.
The burn rate is the rate at which a company uses up (burn through) its cash. It is usually used to describe how emerging companies burn through their initial financing.
However, it may also be used to describe the pace at which any company experiencing declining financial performance is burning through its cash.


