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Cash Flow Statement - Stock Trading Glossary

The cash flow statement, also known as the statement of cash flows, is a financial statement that reveals a company's cash inflows and outflows over a specific time period through three main activities: operating, investing, and financing activities. Publicly traded companies release the cash flow statement, alongside the income statement and balance sheet, as one of the three core financial statements when reporting earnings quarterly and annually.

While the income statement reports accounting earnings, affected by non-cash items, the cash flow statement only portrays actual cash inflows and outflows. This is crucial since cash is essential for a company's survival as it determines whether the business can pay salaries and purchase inventory. Thus, an informed investor must have a solid understanding of the cash flow statement, which contains valuable information to assess the investment's potential.

The cash flow statement displays valuable information about a company's cash inflows and outflows, including where its cash comes from and how it spends its cash. By examining the statement, you can determine if the company generates enough cash inflows to cover its operating expenses, pay off debts, and distribute dividends or buybacks to shareholders.

The cash flow statement comprises three main sections:

  • Cash from operating activities: Also called operating cash flow, it indicates the remaining cash balance after receiving and paying for cash income and expenses related to the core operations.
  • Cash from investing activities: This section lists cash spent on purchasing and selling long-term assets and investments, including capital expenditures.
  • Cash from financing activities: This section demonstrates cash flows between owners, investors, and creditors, such as changes in debt and equity, dividends, and share buybacks.
    The net cash flow is the sum of cash flows from these categories and is frequently displayed as "increase/decrease in cash and equivalents." The net cash flow amount corresponds to the changes in cash and cash equivalents listed on the balance sheet for the same period.

    It's vital to comprehend that revenue and net income (earnings) do not equal the cash gained by a business. The income statement follows the accrual basis of accounting, recognizing revenue and expenses when the product or service is delivered, not when the cash is received.

    For instance, if a customer buys a product on credit, the income statement shows the amount as revenue, but it won't be included in the cash flows until the custtomer pays for the product. Additionally, a writedown of goodwill for an asset may cause a massive reduction in accounting earnings, even if it does not cost the company any cash. This results from an accounting process that reduces the asset's value on the balance sheet.

    Stock-based compensation also affects accounting earnings. When employees receive payment in stock options, their value is deducted from earnings, even though it may have had no impact on the company's cash position at the time. Consequently, examining the cash flow statement, alongside the income statement, is essential to obtain a comprehensive understanding of a company's financial situation.

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