Statement of Cash Flow

The statement of cash flows is one of the four basic financial statements required by GAAP (Generally Accepted Accounting Principles) and IFRS (International Financial Reporting Standards). It is concerned with the flow of cash into and cash out of the business, breaking the analysis down to operating, investing, and financing activities. The statement of cash flows helps investors evaluate the short-term viability of a company, particularly its ability to pay bills.

A substantial, positive cash flow is generally a sign of a healthy company. Investors also must remember that companies in growth mode often have a negative cash flow.

In a statement of cash flows, cash flows are separated into three components: cash flow from operating activities (or cash flow from operations), cash flow from investing activities, and cash flow from financing activities.

Cash flow from operations is the net amount of cash provided by the company’s operating activities. The operating section of the statement of cash flows shows such cash flows as cash received from customers and cash paid to suppliers.

Cash flow from investing activities includes the company’s investments in (or sales of) long-term assets—for example, PP&E and long-term investments in other companies.

Cash flow from financing activities relates to the company’s activities in raising or repaying capital. International Financial Reporting Standards (IFRS) allow the company to classify interest paid as either an operating or financing activity. Furthermore, IFRS allow dividends paid to be classified as either an operating or financing activity. Interestingly, under US generally accepted accounting principles (GAAP), interest expense paid to providers of debt capital must be classified as part of cash flow from operations (as is interest income) but payment of dividends to providers of equity capital is classified as a financing activity.

Working Capital

Working capital is the difference between current assets and current liabilities. It illustrates the amount of liquid assets that a company has to build its business.

Working capital are funds used for operational liquidity. A firm often has day to day liquidity needs that require short term liquidity. Large quantities of working capital indicate potential to expand quickly. Firms needing to make quick equipment purchases through working capital frequently arise. Firms that do not have sufficient working capital (or negative amounts) may find themselves having to borrow the money from other means, slowing down growth.

While having a surplus of working capital is good for growth, excess amounts of working capital may mean the company could find better uses of its current assets.

Formula

Working Capital = Current Assets – Current Liabilities