How to read a cash flow statement

The cash flow statement shows how much cash actually came into and went out of a company during a period, and why. It exists because the income statement uses accrual accounting, which records sales and costs when they are earned or incurred rather than when cash moves. Profit can look healthy while cash is short, so this statement is where investors check whether earnings turn into money.

The three sections

The statement sorts every cash movement into one of three groups and ends with the change in cash:

Cash flow from operating activities (CFO)
+ Cash flow from investing activities (CFI)
+ Cash flow from financing activities (CFF)
= Net change in cash (plus or minus currency effects)
Beginning cash + net change = Ending cash

The ending figure ties to the cash line on the balance sheet.

Operating activities cover the cash effects of running the business: cash from customers, paid to suppliers and employees, plus interest and taxes under US accounting rules.

Investing activities cover buying and selling long-term assets. The main outflow is capital expenditure. Others include acquisitions, purchases and sales of investments, and proceeds from selling equipment.

Financing activities cover transactions with lenders and owners: issuing or repaying debt, issuing stock, repurchasing shares and paying dividends. Under US accounting rules, interest paid sits in operating, while dividends paid sit in financing.

The indirect method

Most companies start the operating section from net income and adjust it back to cash. This is called the indirect method. The adjustments fall into two kinds:

1. Non-cash charges added back, such as depreciation and amortization, stock-based compensation, impairments and deferred taxes. They reduced profit but did not use cash.
2. Changes in working capital items. An increase in receivables or inventory uses cash, so it is subtracted. An increase in payables or deferred revenue holds on to cash, so it is added. See working capital.

Example (illustrative numbers)

In millions of dollars:

Check the arithmetic: 100 + 40 + 15 - 30 - 10 + 20 = 135 for operations; 135 - 80 - 75 = -20 overall. Cash fell by 20 even though the company earned 100, because it spent heavily on assets, an acquisition, debt repayment and shareholder returns. That is not necessarily bad. What matters is whether operations covered those uses. Here operating cash flow of 135 minus capex of 60 leaves 75 of free cash flow, against 50 of dividends and buybacks.

How to read it

Rules of thumb, not guarantees:

• Start with operating cash flow. A healthy established business usually produces positive operating cash flow, and over several years it tends to be in the same range as net income or above it. A long run of net income well above operating cash flow deserves a closer look. See operating cash flow vs net income.
• Look at where investing cash goes. Heavy capex can mean growth or just upkeep of aging assets. Large acquisitions change the shape of the business.
• Look at how financing balances the books. A company that funds its dividends and buybacks from operating cash is in a different position from one that borrows to pay them.
• Read the pattern, not a single number. Negative investing flow is normal for a growing company. Positive financing flow can reflect borrowing or share issuance, which may be good or bad depending on why.
• Use several years. Working capital swings and one-off payments can distort any single period.

Common mistakes and limits

• Assuming negative cash flow is always bad. A growing company investing heavily may show negative free cash flow by choice. The question is whether the spending is likely to earn a good return, which the statement alone cannot say.
• Counting asset sales as earnings power. Cash from selling a business or property appears in investing and is typically a one-time event.
• Ignoring classification choices. Companies have discretion in some areas, such as how certain items are labeled, so compare the line descriptions and notes. Capitalized costs, for example, show up in investing instead of reducing operating cash flow.
• Overlooking stock-based pay. It is added back as non-cash, so operating cash flow can look stronger than the full economic cost of paying staff. See stock-based compensation and dilution.
• Reading it alone. Pair it with the income statement and balance sheet.

Where to see it on StocksXray

Free cash flow and price to free cash flow feed into valuation measures on each stock page. The red flags section also warns when dividends exceed free cash flow. For the underlying statements, use the SEC filings linked from the page.

Key takeaways

• The cash flow statement reports cash movements in three groups: operating, investing and financing.
• Most companies build operating cash flow from net income by adding back non-cash charges and adjusting for working capital.
• Operating cash flow compared with net income, over several years, shows how well profits convert to cash.
• Negative investing cash flow is normal for a business that is reinvesting. What counts is whether operations fund it.
• Always read it alongside the other two statements and the notes.