Let's consider one accounting cycle, with the initial BS, the IS of the year, and the ending BS:
BS year -1 IS year BS year
Furthermore let's assume that:
The objective of the Cash Flow Statement is to explain the evolution of cash (& bank), from 50 to 80, with the help of the big accounting figures:
We shall calculate all the cash inflows and all the cash outflows (don't forget again, here we lump cash & bank).
Of course, the cash inflows are nothing more than debits in the cash (&bank) account.
And cash outflows are nothing more than credits in the cash (&bank) account.
But we do not want to go back to all the details in the journal and the ledger.
We can reconstitute the cash movements from the synthetic figures in the BS and IS. And it will give a useful overview of our sources and uses of cash.
In the previous lesson, we saw that value is important, but what makes a firm succeed or go bust is cash. And we tried to explain at a fundamental level what is cash.
So we need to have a clear understanding of where our cash came from, where it went, and also be able to forecast these movements next year (this requires cost accounting).
Cash inflows can come from 4 sources:
Cash from sales.
Here, we have to be a bit careful: all sales don't bring immediately cash, because some are on credit.
Secondly, IOU's from last year may have become cash.
So we have to take into account the variation of the clients (or debtors) account.
Another way to understand this is to think of the client account as a bathtub with water flowing in, and water flowing out:
If we consider that cash sales are on credit with a credit duration of zero, then all sales are on credit.
The sales fill in a "bathtub", the client account. And the "bathtub" lets cash out from its sink.
Therefore the cash from sales equals all the sales minus the increase in water volume.
More mathematically we have
cash from sales = sales - Δ clients
With the figures of our example, this gives cash from sales = 1000 - (270 - 200) = 930.
Another image than the "bathtub" is to view the client account as a buffer, like when we need to bufferize a bit a video in order to view it comfortably.
The other sources of cash, in our example, did not produce any cash: during the cycle there were no divestments, no new capital, and no new borrowings.
Let's now turn to cash outflows (also called cash outlays).
The causes of cash outflows (i.e. credits in the cash&bank accounts) are:
Cash outflow for Purchases.
Just like we corrected Sales, to obtain cash from sales, we correct Purchases to obtain cash outlays for purchases
The formula is
cash out for purchases = purchases - Δ suppliers
(remember that, to make the explanations simple, we assumed that the suppliers account is the buffer only for purchases)
With the figures of our example, this gives cash out for purchases = 500 - 20 = 480.
Cash outflow for operating charges.
This expenditure is simple: we count the cash operating charges (if we pay them entirely with cash&bank) and, of course, we don't have to worry about the amortization which is a "non-cash" operating charge (the cash of the investment was paid at another time, or perhaps even not yet paid, but it's not taken into account here).
Salary + fringes = 150
Rent = 50
Other cash charges = 50
So the cash outflow for operating charges is 250.
(Remember that all these were, simply enough, credits in the cash&bank account.)
Outflow for interest charges, taxes and dividends.
Here we take into account the "buffering" liability account "other creditors". The variation of the "other creditors" is 90 - 50 = 40.
So the cash outlay for interest charges, taxes and dividends is 10 + 20 + 30 - 40 = 20.
Finally there were cash outlays for investments.
There were long term investments during the cycle since buildings went from 100 to 125, machinery from 100 to 150, and transportation equipment from 50 to 75.
So Δ Gross Fixed Assets = 100. (Remember that we assume that there was no divestment, and that the investments were paid cash. Otherwise we would introduce a "buffering" effect from one of the liability accounts.)
And there were short term investments since the ST financial securities went from 70 to 120.
The cash outlays for investments were 100 + 50 = 150.
Total cash outlays:
total = 900.
We are now ready to present the Cash Flow Statement:
Total cash inflows = 930 (= sources of cash during the year)
Total cash outlays = 900 (= uses of cash during the year)
Therefore Δ cash (&bank) = +30
And this, indeed, is the evolution of the cash & bank balance from 50 to 80.
The cash flow statement is the third important year-end document, after the income statement and the balance sheet.
There are several presentations of this document. We showed one of them.
On the website of yahoo finance, the page of each firm listed in the stockmarket presents, in its financials section, the three year-end documents: