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Cash flow satatement

Did you know that Apple has USD 94 Bn Cash with itself? That is more than the GDP of 66% of the countries of the world. Yes you heard it right! I am not speaking about 66% companies I am speaking about 66% of the COUNTRIES!

That was slightly off track!

In this part, we start building the most important financial statement: Cash flow statement!

What is Cash flow Statement?

I always say that Cash Flow Statement is the ONLY true statement in all the financial statements. It speaks about the real cash. The rest (Profit and Loss Statement of Facebook and Balance Sheet of Facebook) are accounting statements and I think they are just views! Cash flow statement speaks about how much cash flowed in and how much flowed out. REAL CASH!

How to Create Cash Flow Statement

There are 2 methods of creating the cash flow statement

  • Direct
  • Indirect

Direct is possible only if you have all the accounting entries with you (how much the company purchased, what out of it was cash, what was on credit etc.). Unfortunately we don’t have that luxury.We just have the historical broad numbers with us! So we would be creating the Cash Flow Statement of Facebook through the indirect method

Cash Flow Template

My experience of modeling says that, Creating the Cash Flow Statement is a simple exercise for those who know but is tricky for those who don’t (This statement is like the golden rule of Investing: BUY LOW SELL HIGH!)

I am giving you the template of an empty cash flow statement. Why don’t you try to create it on your own?

We would be releasing the tutorials on the process to create the cash flow statement and I would keep guiding you on the process.

So what is the Cash Flow Statement?

Basically the Cash Flow Statement describes the sources and uses of a company's over a specified time period i.e. explains the changes in cash and cash equivalents during a period.

P&L or the income statement, which is prepared by accrual accounting is more of a view: A company may show profits and not generate any cash at all. The cash flow statement is a real statement and neutralizes the impact of the accrual entries on the other financial statements.

What is the structure of the cash flow statement?

It categorizes the sources and uses of cash to provide the reader with an understanding of the amount of cash a company generates and uses in its operations, provided by sources outside the company -borrowed funds or funds from stockholders, etc. The cash flow statement also tells the reader how much money was spent for items that do not appear on the income statement, such as loan repayments, long-term asset purchases, and payment of cash dividends.

Cash flow statements classify cash receipts and payments according to whether they stem from operating, investing, or financing activities.

What are the methodologies to create the Cash Flow Statement

We may prepare using the direct or indirect method. Usually in the S1 filing, you would find the cash flow statement from the indirect method. We can also derive the cash flow statement using the indirect method. Obviously not all line items might match with the statement published by the company, but broadly the sense of the statement would be achieved.

Steps in creating the Cash Flow Statement through the indirect method

Creating the financial statement is a tricky process if you are doing it for the first time. But once you know the algorithm, then creating the cash flow statement is like playing hangman, just make sure that you get the steps right.

There are two important steps (and one optional)

  1. Categorizing the Balance Sheet Items in Operating, Investing and Financing Activities
  2. Calculating the changes in Balance Sheet items and remembering that increase in assets is decrease in Cash
  3. (If Required) Match the P&L numbers to the difference in Balance Sheet

Analyzing and Classifying Balance Sheet Items

In this tutorial we discuss the first step in creating the Cash Flow Statement: Classifying the items in the Balance Sheet. Basically the classification has to be in one of the three parts of business:

  • Operational: Anything related to core operations of the business (Sale, Purchase, Inventory, etc.)that has a short term (<1 Year) impact
  • Investing: Anything that has a long term (> 1 year) implication (Plant, Machinery, Capital Expenditures, etc.)
  • Financing: Changes in sources of funds (New Debt, Equity, etc.)

Categorizing the Balance Sheet items in Facebook

In this figure you can see how the Facebook Balance Sheet items are categorized into different activities in the Cash Flow Statement.

Next Steps

In the next step, we move forward and see how changes in B/S can be used to estimate the amount of cash consumed/ released from the business

Keep Modeling!


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