Reading a cash flow statement as an owner
How an owner should read the operating, investing and financing sections of a cash flow statement, what it shows that profit hides, and where to get one.
By Achekam · · 4 min read · For Running a business businesses in South Africa, Nigeria, Kenya
The income statement says the business made a profit. The bank balance says otherwise. Owners in that position usually conclude that one of the two must be wrong. Neither is. They measure different things, and the statement that connects them, the cash flow statement, is the one most owners skip when the annual financial statements arrive.
It is worth reading. In a page, it tells you where the year's cash came from and where it went, which the income statement cannot do. This article explains its three sections, the questions each one answers, and how to get one if your monthly figures do not include it.
Three sections, one total
Investopedia defines a cash flow statement as a financial statement showing how much cash comes into and goes out of a business over a period, used to judge its liquidity and financial stability. It explains that the statement has three sections, for operating, investing and financing activities, and that the sum of the three is the net cash flow for the period.
| Section | The question it answers |
|---|---|
| Operating activities | Did the day-to-day business generate cash, or consume it? |
| Investing activities | How much went into (or came out of) long-term assets? |
| Financing activities | How much came from, or went back to, lenders and owners? |
| Net cash flow | Did the cash balance rise or fall over the period, and by how much? |
Read them in that order. A healthy business usually generates cash from operations, spends some of it on assets, and uses the rest to repay loans or pay owners.
Operating activities: the business itself
Investopedia explains that the operating section reports cash flows directly related to the main business, such as buying and selling inventory and supplies and paying salaries, and leaves out investments, debts and dividends.
This is the section that answers "is the business paying its own way?" If operating cash flow is negative year after year, the business is being kept alive by borrowing or by the owner's money, however good the profit looks.
Profit on credit sales, without the cash
Investopedia warns that a business recognising credit sales as revenue earns a profit on the income statement without yet having the cash, and that if this happens too often it can run out of cash despite being profitable.
A worked example in words. A Kenyan equipment supplier has its best year: large orders, on 60-day terms, many invoiced in the last two months of the year. The income statement shows a strong profit. The operating section of the cash flow statement shows much less cash generated, because the year-end debtors are far higher than they were a year before. The stock built up to fill the orders also absorbed cash. The supplier is profitable and short of cash at the same time, and the cash flow statement shows exactly why: debtors and stock.
When you read this section, look for the lines that reconcile profit to cash. Increases in receivables and inventory reduce cash; increases in what you owe suppliers add to it.
Investing activities: what capital spending tells you
Investopedia explains that the investing section includes cash spent on property, plant and equipment, and that this is where analysts look for changes in capital expenditure.
For an owner, the questions are:
- Is the business replacing what wears out? Very little spending year after year may mean vehicles and equipment are ageing without replacement.
- Was a large purchase funded sensibly? A big outflow here, matched by a loan in the financing section, is a planned investment. A big outflow here with nothing in financing came out of working cash.
- Were assets sold? Cash in from disposals can flatter a year; it does not recur.
Financing activities: loans, owners and dividends
Investopedia explains that the financing section measures cash flows between the business and its owners and creditors, such as money raised by issuing shares or borrowing, and payments of dividends or loan repayments.
Read it alongside the operating section. A business that repays loans and pays dividends out of operating cash is strong. One that borrows each year to cover operating outflows is on borrowed time. Owners' drawings or dividends taken in a year of weak operating cash flow deserve a hard look.
Getting a cash flow statement when the books do not produce one
Achekam's management accounts show an income statement for a chosen period beside the period before and a balance sheet at period end, but the books do not produce a cash flow statement. For month-to-month cash, the bank balance and the balance sheet movements are your guide; for the full statement, you need your accountant.
A business on Achekam can appoint its accounting firm by the firm's Achekam address or firm code, and the appointed firm works directly in the business's own ledger, with no copy made. If that firm prepares your annual financial statements in Achekam, its financial statements Studio builds a draft set from the mapped trial balance, including the four primary statements. The cash flow statement's current-year column is worked out from the change in balances, and the accountant can type a figure for any line, which then takes priority. What the Studio produces is a draft for your accountant to review.
So the routine is: read your management accounts monthly, and when the annual statements arrive, turn to the cash flow statement before the profit.
For more on the gap between profit and cash, see why a business can show profit but have no cash and working capital explained.
Read it next to the profit
Investopedia's guide to reading a cash flow statement and its three sections goes through each section with examples. Ask your accountant to walk you through last year's cash flow statement line by line, and note the two or three lines that moved cash the most; those are the ones to manage this year.
General guidance only, not advice on your own circumstances. Tax and payroll rules change: check the current position with the authority or your adviser.
