Why do companies fail? You might think it’s because they aren’t making enough profit — but more often, the real killer is something far less glamorous: cash, or rather, the lack of it. You can be showing profits on paper and still find yourself unable to pay the bills, meet payroll, or keep the lights on. It’s a bit like owning a gold mine but not having enough fuel to drive it to the bank. The history books are littered with examples of once-profitable companies that collapsed because they ran out of cash. Take Toys “R” Us, for example — still profitable before filing for bankruptcy in 2017 but crushed under the weight of debt repayments and poor liquidity. Or Carillion, the UK construction giant, which booked profits even as its cash reserves dwindled — until it all came crashing down in 2018. In business, cash isn’t just king — it’s oxygen. And the best place to understand how much you’re generating, and where it’s going? The Cash Flow Statement.

Article Contents

• What is a Cash Flow Statement?
• Why Cash Flow Statements Matter
• Key Components of a Cash Flow Statement
• Cash Flow Statement Example
• Cash Flow Statement Format in Excel
• Depreciation in Cash Flow Statements
• Analysing a Cash Flow Statement
• What Does a Cash Flow Statement Show?
• Common Mistakes When Preparing Cash Flow Statements
• Common Interview Questions regarding Cash Flow Statements
• FAQs

What is a Cash Flow Statement?

A cash flow statement, also known as a statement of cash flows, is one of the primary financial statements (along with the P&L and Balance Sheet) and it summarises how a business manages its cash position by tracking the inflow and outflow of cash during a specific period. The great insight from a Cash Flow Statement comes from the 3 key headings it presents – cash generated / used in operating activities (CFO), investing activities (CFI) and financing activities (CFF). This structured format provides a clear picture of a company’s liquidity and solvency, and most importantly “is the business model working?” – evident in its cash flow from operations.  

Why Cash Flow Statements Matter

1. Liquidity Assessment: They help determine if a company can meet its immediate obligations.
2. Operational Efficiency: They reveal how effectively a business generates cash from operations.
3. Investment Decisions: They show how much capital is being invested in growth opportunities.
4. Financial Health: They provide insights into the sustainability of business operations.
5. Strategic Planning: They assist in making informed decisions about future cash requirements.

Key Components of a Cash Flow Statement

The cash flow statement consists of three main sections:

1. Operating Activities:
   • Cash received from customers
   • Cash paid to suppliers and employees
   • Interest and taxes paid
   • Other operating cash flows
2. Investing Activities:
   • Purchase or sale of fixed assets
   • Acquisition or disposal of investments
   • Loans made to others
   • Purchase or sale of securities
3. Financing Activities:
   • Issuance or repurchase of shares
   • Borrowing or repayment of loans
   • Payment of dividends
   • Other financing-related cash flows

Cash Flow Statement Example

Let’s consider a simplified cash flow statement example:

Unilever PLC

Cash Flow Statement for the year ended 31 December 2024
(All figures in €m)

How to Prepare the Cash Flow Statement Above

Preparing a cash flow statement involves several steps:

1. Gather Required Information
   • Balance sheet for two consecutive periods
   • Income statement for the period
   • Additional transaction details
2. Calculate Operating Activities
   • Start with operating profit from the P&L (some companies will start with Net Income, but this is not prescribed by accounting standards)
   • Operating profit is then adjusted for non-cash operating expenses (here, Depreciation and Share-based payments).
   • Then “Change in operating working capital” shows operating cashflows that are not included in the P&L – relating to Working Capital (Inventory, Receivables and Payables)
   • This number is essentially the net change in Inventory + Receivables – Payables. This net figure increasing is an additional use of cash and will be a negative adjustment here, and vice versa for a decreasing balance.
   • Why? With inventory, the Cost of Sales in the P&L only includes the cost of inventory that has been sold, not what has been purchased! So, if a company has increasing inventory levels this is additional cash commitment that needs to be adjusted for. With receivables, sales revenue in the P&L is recorded as it is ‘earned’ (invoiced) using the accruals concept but not necessarily received. So, with increasing receivables levels it means the company has not collected as much cash as shown as Revenue in the P&L. Conversely with Payables, the P&L shows all expenses incurred (but perhaps not yet paid!). So, increasing payables means expenses in the P&L have not been paid in cash. This adjustment arises because the P&L operating profit is calculated on an accruals (rather than cash) basis – recognising revenue as earned, expenses when incurred (not based on cash received /paid!)
   • You will also note above a number of other adjustments, the most commonly seen being:
     1. Reversal of profit/loss on disposal of assets. Any profit or loss on selling fixed assets will be included in Operating Profit in the P&L. In the cash flow, however, this is removed and, instead, the cash received from a sale, is shown under the heading “Investing Activities” (in our example, Net Capex is net of cash received from sales)
     2. Tax paid. Although for many people this is not considered a true ‘operating’ cash flow, if the company had no operating profit it would pay no tax. Also, consider that it is certainly not a Financing activity nor an Investing activity!
3. Calculate Investing Activities
   • Record all investment-related cash flows (relating to Fixed Assets, other businesses, financial assets)
   • Include cash received from sales as well as cash invested in buying assets.
   • This information will come from the Notes to the Financial Statements
4. Calculate Financing Activities
   • Document all financing-related cash movements
   • Include debt and equity (and hybrid) transactions
   • Any funding grants from government authorities would also be included here
5. Determine Net Cash Flow
   • Sum the cash flows from all three sections
   • Reconcile with the change in cash position

Cash Flow Statement Format in Excel

Creating a cash flow statement in Excel involves:

1. Setting up the Template:
   • Create separate sections for operating, investing, and financing activities
   • Include formulas for automatic calculations
   • Set up proper formatting and cell references
2. Data Input:
   • Enter historical financial data
   • Include current period transactions
   • Set up linking between worksheets (e.g. linking the EBIT in from the P&L, the Change in Working Capital from the balance sheet)
3. Automation:
   • Use Excel functions for calculations
   • Create validation checks
   • Implement error-checking formulas

Depreciation in Cash Flow Statements

Depreciation plays a unique role in cash flow statements:

• It’s added back to operating profit (or net income) in the operating activities section of the Cash Flow Statement.
• Why? It’s a non-cash expense that reduces operating profit and net income, so if we are adjusting Operating Profit to arrive at Operating Cash Flows it must be added back, along with any other non-cash expenses included in Operating Profit.
• Depreciation is purely an accounting matching concept that is conceived to match the cost of assets to their useful life.
• It affects the calculation of free cash flow if using this ‘indirect’ method of deriving cash flows from the Operating Profit.

Analysing a Cash Flow Statement

When analysing a cash flow statement, consider:

1. Operating Cash Flow Ratio
   • Operating cash flow / Current liabilities
   • Indicates ability to cover short-term obligations
2. Free Cash Flow
   • Operating cash flow – Capital expenditures
   • Shows cash available for discretionary spending
3. Cash Flow Coverage Ratio
   • Operating cash flow / Total debt
   • Measures ability to repay debt
4. Quality of Earnings
   • Compare operating cash flow to net income
   • Assess earnings quality and sustainability

What Does a Cash Flow Statement Show?

A cash flow statement shows:

1. Cash generated from core business operations
2. Investment in long-term assets and growth
3. Financing activities and capital structure changes
4. Overall change in cash position
5. Sources and uses of cash
6. Liquidity and solvency position
7. Quality of earnings
8. Sustainability of business model

Common Mistakes When Preparing Cash Flow Statements

Avoid these common errors:

1. Misclassifying cash flows between categories
2. Incorrect treatment of non-cash transactions
3. Failing to reconcile with other financial statements
4. Overlooking important working capital changes
5. Incorrect treatment of foreign currency transactions
6. Mishandling of complex transactions

Common Interview Questions Regarding Cash Flow Statements

1. What is the difference between direct and indirect methods of preparing a cash flow statement?
   Above, with Unilever, we have shown the most commonly used method of presentation – the Indirect Method, where Operating cash flow is derived from Operating Profit. In some countries (e.g. Australia), the Direct Method is more commonly encountered. With this presentation method, CFO is not derived from EBIT; instead, it is simply presented as:
   • Cash received from Sales
   • Cash paid to Suppliers
   • Cash paid for operating expenses (e.g. marketing, staff costs, distribution, IT)
   • Cash tax paid… etc.

   Some people argue that the Indirect method is more useful as it shows the relationship between Profit and Cash – a useful insight for investors.

2. How does depreciation affect cash flow?
   See above.
3. Why might a profitable company have negative cash flow?
   Consider changes in working capital (e.g. if a company is rapidly growing it will be investing heavily in inventory and extending credit to customers. Also consider Investing activities and Financing Activities that do not impact profit).
4. How do you calculate free cash flow?
   See our blog on Free Cash Flows as there are a number of definitions. The most common is Free Cash Flows to the Enterprise being EBITDA – changes in working capital – net Capex – tax on operating profit.
5. What are the key indicators of healthy cash flow?
   Essentially you would look for consistent positive operating cash flows, not diverging from operating profit (although it will be different, its relationship to operating profit should not change unexpectedly).
6. How do changes in working capital affect cash flow?
   Define working capital (as above) and explain that the P&L is prepared on an accruals (non-cash) basis. So incremental investment in net working capital (Inventory + Receivables – Payables) is a use of cash that needs to be noted in the Cash Flow Statement.
7. What is the significance of negative operating cash flow?
   Firstly, is it consistently negative? In which case it means the business model is not working, or the company is rapidly expanding (which isn’t bad, as long as the Financing Cash Flows are strong). No company will survive is operating cash flows remain negative, so it is vital to evaluate and understand the reason for negative operating cash flows – is it a one-off, or a sign of a weak operating model?
8. How do you reconcile net income to operating cash flow?
   See the steps above in our Unilever example.

Understanding cash flow statements is crucial for financial professionals. They provide vital insights into a company’s cash management, operational efficiency, and financial health. Whether preparing, analysing, or interpreting cash flow statements, attention to detail and understanding of fundamental principles are essential. Regular review and analysis of cash flow statements help in making informed business decisions and maintaining financial stability.

Remember that cash flow statements should be analysed alongside other financial statements for a complete picture of a company’s financial position. Regular monitoring and proper preparation of cash flow statements are essential for effective financial management and strategic planning.