The statement of cash flows shows how a company spends its money (cash outflows) and where the money comes from (cash inflows). The cash flow statement includes all cash inflows a company receives from its ongoing operations and external investment sources, as well as all cash outflows that pay for business activities and investments during a given quarter. In this article, we'll explain the cash flow statement and how it can help you analyze a company for investing.
Why The Cash Flow Statement Is Important
There are two forms of accounting: cash and accrual.
Accrual accounting is used by most public companies and is the accounting method where revenue is reported as income when it's earned rather than when the company receives payment. Expenses are reported when incurred even though no cash payments have been made.
For example, if a company records a sale, the revenue is recognized on the income statement, but the company may not receive cash until a later date. From an accounting standpoint, the company would be earning a profit on the income statement and be paying income taxes on it. However, no cash would have been exchanged. Also, the transaction would likely be an outflow of cash initially since it costs money for the company to buy inventory and manufacture the product to be sold. It's common for businesses to extend terms of thirty, sixty, or even ninety days for a customer to pay the invoice. The sale would be an accounts receivable with no impact on cash until collected.