A cash flow statement is a summary of a company's cash inflows and outflows during a period.
Note that it is different from an income statement, as it only tracks cash receipts and cash payments and not non-cash transactions.
Think of it as the company's bank account. It only keeps track of money inflow and outflow during the period in consideration. Like an income statement, a cash flow statement is prepared for a period of time. This can be quarterly, half yearly or yearly.
A cash flow statement can be used to measure a company's capacity to generate cash. You can also see its sources of cash and how it spends cash.
The cash flow statement generally has three components - cash flow from operations, cash flow from investing, and cash flow from financing.
Let’s look at the cash flow statement of Varun Beverages to understand this better.
Below is the Cash Flow Statement of Varun Beverages for the year ended December 31, 2021.
Note that the first line item in the cash flow statement is Profit before tax (PBT)* which is directly picked from the income statement. Since PBT includes both cash and non-cash transactions, we make certain adjustments (discussed below) to arrive at the actual cash generated from operations in a period. To this, we add cash generated from investing and financing activities. The total of the three is net cash generated by a company during a period which is the last line of the cash flow statement. This number goes to the balance sheet and is listed as ‘cash and cash equivalents’ under current assets.
*Note: Some companies start with net income which is PBT less tax expenses.
Cash flow from operations
Cash flow from the core revenue-generating activities of a business are recorded in this section. For example, salaries paid to employees, cash paid to vendors/suppliers, cash collected from customers, and income tax paid. Note, that the Profit Before tax, the first line item of the cash flow, reflects most of these adjustments. However, as PBT comes from Income Statement which is formed an accrual basis, it also includes the non-cash components. Hence, through the Varun Beverages statement, we will learn how to make these adjustments to PBT.
As we had mentioned earlier in this chapter, PBT is not a correct representation of cash generated from operations as they include non-cash transactions. Let’s look at the cash flow statement of Varun Beverages for the year ended December 31, 2021, to understand what these adjustments are made to PBT to arrive at net income from operations.
Non-cash items: These are expenses listed on an income statement, such as depreciation and amortisation, and other allowances/provisions, that does not involve a cash payment. Hence, these are added back to the PBT.
Accrued items: These include incomes and expenses for the period for which no cash transaction has yet been made. For example, Varun Beverages’ cash flow statement includes interest income/expenses. These interest expenses and income are what is to be paid or received and are not what is actually paid or received.
Non-operating items: These include transactions that are not part of Varun Beverages’ core operation and are better defined as investing or financing activities. For example, ‘profit on sale of current investments’ and ‘loss on sale of property, plant and equipment’.
Working capital adjustments: These are changes in the value of current assets and current liabilities year over year. When current assets increase, they are subtracted and vice versa. Meanwhile, when current liabilities increase they are added and vice versa.
For example, in the cash flow statement of Varun Beverages, trade receivables have a positive value associated with it. This means trade receivables decreased this year compared to last. What do you think happened? Yes, some customers who had bought goods on credit last year, paid cash this year. While the sale made to them passed through the income statement last year, the cash was only received this year. Hence, it is added to the PBT.
Cash flow from investing
All transactions related to investments are recorded in this section. These include sale/purchase of fixed assets, sale/purchase of investment securities, lending money etc.
In the cash flow statement of Varun Beverages, purchase of property, plant and equipment has a negative value associated to it. This is because cash left the book when they were purchased.
Cash flow from financing
Cash generated or spent on financing activities are recorded in this section. For example, dividend and interest payments, stock repurchases, bond issuance and redemption.
In the cash flow statement of Varun Beverages, we can see proceeds from long-term borrowings. This is because VBL raised money from long-term debt, the other side of this entry would create a liability and would be listed as long-term borrowing under non-current liabilities.
