BA-301 · Lesson 3 of 9

The Cash Flow Statement

You understand how cash is generated and used, and why accounting profit is not the same as cash received.

15 min read Advanced Financial Statement Analysis
Track contents Financial Analysis for Investors
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BA-301 · Financial Statement AnalysisThe Balance Sheet: Assets, Liabilities and EquityThe Income StatementThe Cash Flow Statement
BA-302 · Valuing Listed CompaniesProfitability and Leverage RatiosMarket MultiplesThe Discounted Cash Flow (DCF) Method
BA-303 · Portfolio ManagementDiversification and Asset AllocationMeasuring RiskBuilding and Rebalancing a Portfolio

Why cash matters

Profit is calculated using accrual accounting: revenue and expenses are recognized when they are earned or incurred, not when cash is received or paid. That is why a company can report a profit and run out of cash at the same time. The cash flow statement reconciles these two perspectives.

For an investor, the cash flow statement is often the hardest of the three reports to "adjust," because cash coming in or going out can be verified. It shows whether the core business funds its own investments, how far the company depends on new loans or shareholder contributions, and whether dividends are backed by the cash it generates. Read together with the balance sheet and the income statement, it completes the economic picture of the issuer.

The indirect method for operating activities

Most issuers present operating cash flow using the indirect method: they start from net profit and adjust it for non-cash items and for changes in working capital.

  1. Start from net profitThis is the starting point of the reconciliation.
  2. Add back non-cash itemsDepreciation and amortization reduce profit but do not involve a cash outflow in the current period.
  3. Adjust for working capitalAn increase in receivables or inventories consumes cash (deducted); an increase in trade payables to suppliers keeps cash in the company (added).
  4. Arrive at cash flow from operating activitiesThe result shows how much cash the core business actually generated.

The classification of some items, such as interest paid or dividends received, may differ between issuers, because IFRS allows certain choices. In the example below, interest is included in operating cash flow.

Example: from profit to cash

Nistru Agro SA — item (MDL thousand, illustrative)Amount
Net profit7,040
+ Depreciation and amortization3,000
− Increase in receivables(1,200)
− Increase in inventories(800)
+ Increase in trade payables460
Cash flow from operating activities8,500
− Purchases of equipment (CAPEX)(5,000)
+ Proceeds from the sale of equipment300
Cash flow from investing activities(4,700)
− Loan repayments(2,500)
− Dividends paid(1,000)
Cash flow from financing activities(3,500)
Net change in cash300
Cash at the beginning of the year2,000
Cash at the end of the year2,300

Free cash flow and warning signs

Free cash flow (FCF)
FCF = Cash flow from operating activities − Capital expenditure (CAPEX)
This is a simplified, widely used definition. Valuation uses more precise variants, such as free cash flow to the firm (FCFF), discussed in the lesson on DCF.

FCF shows the cash left after maintaining and expanding the asset base, available for repaying debt, paying dividends or buying back shares. In the example, the company generated MDL 3,500 thousand of FCF and used MDL 3,500 thousand for financing, keeping its cash position almost unchanged.

  • Net profit rising while operating cash flow falls for several consecutive years.
  • Dividends consistently funded by new borrowing rather than free cash flow.
  • Receivables systematically growing faster than revenue.
  • CAPEX below depreciation over the long term, which may indicate underinvestment.

Key takeaways

  • Accounting profit and cash differ because of non-cash items and changes in working capital.
  • Cash flows are split into operating, investing and financing activities; their sum is the net change in cash.
  • Increases in receivables and inventories consume cash; an increase in trade payables keeps it in the company.
  • FCF = operating cash flow − CAPEX shows the cash available to creditors and shareholders.
  • Profit that does not turn into cash over the long term is a warning sign.

Check your knowledge

Answer all the questions. If you answer all of them correctly, the lesson is marked as completed automatically.

Question 1 of 3How does an increase in trade receivables affect cash flow from operating activities (indirect method)?

Explanation: An increase in receivables means revenue has been recognized but not collected; the adjustment is deducted from net profit.

Question 2 of 3Operating cash flow is MDL 8,500 thousand, CAPEX is MDL 5,000 thousand and dividends paid are MDL 1,000 thousand. What is FCF under the simplified definition?

Explanation: FCF = 8,500 − 5,000 = MDL 3,500 thousand. Dividends are a use of FCF and are not deducted when calculating it.

Question 3 of 3Which category does the repayment of a bank loan fall into?

Explanation: Raising and repaying loans changes the financing structure and is presented under financing activities.

Finished the lesson?Mark it as completed to track your progress.

Educational material only. It does not constitute investment, legal or tax advice. Numerical examples are hypothetical.