The Cash Flow Statement

Why this matters

A company pays its bills with cash, not with profit. The SEC's guide notes that a company needs enough cash on hand to pay its expenses and buy assets, and that the cash flow statement shows whether it's actually generating that cash.¹ Profit and cash can drift far apart, and this is the statement that shows by how much.

Line item	This year	Last year
Operating activities
Net income	58	44
Depreciation	25	22
Stock-based compensation	5	4
Increase in accounts receivable	(6)	(5)
Increase in inventory	(5)	(6)
Increase in accounts payable	3	2
Increase in accrued expenses	1	1
Increase in deferred revenue	3	4
Cash from operating activities	84	66
Investing activities
Capital expenditures	(40)	(35)
Cash from investing activities	(40)	(35)
Financing activities
Debt repaid	(10)	0
Dividends paid	(14)	(12)
Cash from financing activities	(24)	(12)
Change in cash	20	19
Cash at the start of the year	40	21
Cash at the end of the year	60	40

STU Corp is fictional. Amounts in $ millions. Numbers in parentheses are subtracted.

The three sections

The cash flow statement has three parts, one for each kind of activity:¹

• Operating activities: cash from running the business.
• Investing activities: cash spent on, or received from selling, long-term assets such as equipment, and investments. Buying is an outflow, selling an inflow.
• Financing activities: cash from borrowing or selling shares, and cash used to repay loans, pay dividends, or buy back shares.

Add the three together and you get the change in cash for the year: for STU Corp, $84 million − $40 million − $24 million = $20 million, which takes its cash from $40 million to the $60 million on its balance sheet.

From net income to operating cash flow

The operating section starts with net income, then adjusts it to cash.¹ Each adjustment answers one question: did this line move cash differently from how it moved profit?

• Depreciation, +$25 million. It reduced profit, but no cash left this year. The cash went out when the equipment was bought.
• Stock-based compensation, +$5 million. Employees were paid partly in shares. It's a real cost, but it used no cash.
• Increase in accounts receivable, −$6 million. Some of this year's sales haven't been paid for yet, so profit counted money that hasn't arrived.
• Increase in inventory, −$5 million. Cash went into stock that hasn't been sold yet.
• Increases in payables and accrued expenses, +$4 million. Some costs were counted but not yet paid, so the cash is still in STU Corp's account.
• Increase in deferred revenue, +$3 million. Subscribers paid in advance, before the revenue was counted.

The pattern is worth memorizing. When an asset like receivables or inventory grows, it absorbs cash. When a liability like payables or deferred revenue grows, it holds on to cash. That's how STU Corp turned $58 million of net income into $84 million of operating cash flow.

The rest of this lesson is for members

Still to come in this lesson: Free cash flow, the key takeaways, and 2 quiz questions with explanations.

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