How to Read a Statement of Cash Flows

Wondering where your cash is really going? It’s time to find out. In this video, Steve breaks down the statement of cash flows step by step—so you can finally understand how money moves through your business.

You’ll learn how to read and interpret operating, investing, and financing activities, spot early warning signs, and use cash flow insights to make smarter, more confident decisions.

If you’re ready to take control of your finances and stop being surprised by your bank balance, this is a must-watch.

TRANSCRIPT:

Hey, it's Steve. In this video, I'm gonna walk you through how a statement of cash flows works from a CFO's perspective. Now, I'm going to abbreviate and keep things really high level, starting with this statement of cash flows, because I wanna keep your learning efficient.

Now, the statement of cash flows is the most important financial statement in business, but it's oftentimes the most neglected. And here's the deal. 70% of companies that go bankrupt are actually profitable when they close their doors.

And you may be wondering, how's that possible? They have profit. How are they not in business? It's because profit doesn't equal cash flow. And cash flow is gonna be computed from the statement of cash flows. I'll show you how that happens. So first, we have net income. That's the beginning line item on the statement of cash flows.

We have net income here. Now, net income, like I said, is not profit. Instead, this is just flowing through from the income statement. So we have the income statement here. We end up with net income, and this flows over here to the statement of cash flows and makes up the first line item. Now, we're trying to get to cash, so we have to make adjustments for non-cash items.

Now, some non-cash items may include depreciation and amortization, or maybe we have a gain or a loss on a piece of equipment. These are non-cash items that are in the income statement that are part of this net income number, and we have to make adjustments because they aren't true cash outflows. So think about it.

With depreciation and amortization, you buy a truck, it's $50,000. It's gonna last for five years. You're depreciating it $10,000 a year. So that's being recorded up here in net income, but you've already purchased the truck back in the day, and that was an outflow of CapEx, which I'll get to in just a minute. So if you count depreciation and amortization, and it's not like you're writing a check to Mr. or Mrs. Depreciation, right? So if you count that and you don't add it back, then you're gonna be underestimating or misstating your cash flow. So we have to account for that.

The same thing is true with a gain or loss on a sale of a piece of equipment. It's recorded up here in net income, but when you sell that piece of equipment, you're just writing off the book value that's on the balance sheet, and that gain or loss is not a true cash item. So we have to add non-cash items back to our net income number, and then we also have to account for changes in working capital.

So on the balance sheet, we have two periods, okay? This is period one and this is period two. We have current assets and we have current liabilities on both of these balance sheets. Now, current assets go up, current assets go down. They go all over the place. Same thing is true with current liabilities. If I illustrate it here with these buckets, might be a better example.

My buckets are terrible here. These are not the buckets you'd get at Home Depot, but let's just say these are current assets, current assets, current liabilities, current liabilities, and over these periods, let's just say you have current assets, you have a bunch of cash, accounts receivable, inventory, it's really high, and then the cash balance goes down here. Over the next period, current liabilities is down low and current liabilities climbs.

In the next period, these fluctuations are gonna have an impact on cash. In other words, when current assets increase, it means you're going to have less cash. And when current liabilities increase, it means you're going to have more cash.

Now, if that's confusing to you, don't worry. You're in the same boat of a lot of other people. If you wanna learn more about working capital, you can go to my Boosting Your Financial IQ podcast. I just released two episodes on working capital specifically, and I walk you through the details and the mechanics of all this, which will help you out a lot if this is confusing. But let me just try to explain this from a high level but not get distracted from the main point, which is the saving of cash flows. But I want you to understand working capital because it's critical. It could kill a business if you don't watch it carefully. Think about with current assets. Let's just take accounts receivable.

This is the amount of money your customers owe you. And let's say your accounts receivable balance right here is high, and then you collect your accounts receivable, so you're collecting money from your customers, and it drops. Therefore, accounts receivable decrease, so it means you have more cash.

Because remember, current assets go up, you have less cash, they go down, you have more cash. In other words, a customer owes you $1,000 one month. The next month, they owe you $500. That means they paid you $500 in cash, and therefore you have more cash. Conversely, you have $1,000 that customers owe you, and then you build more customers, and that balance climbs to 3,000. Well, that means you're not collecting on that accounts receivable, and therefore you have less cash because that cash is sitting in the pockets of your customers.

The same thing is true with current liabilities. If we just look at accounts payable, for an example, and you have money with trade vendors, you go and buy a bunch of materials from your vendors, they give you an invoice. Well, if that balance climbs, in other words, if current liabilities increase, it means you're sitting on the cash that is due and payable to your trade vendors.

Therefore, you're gonna have more cash. So current liabilities go up, you're gonna have more cash. Current assets go up, you're gonna have less cash.

All right, just think about it in the terms of buckets. But when we take this, this change in working capital, these fluctuations from one period to the next on the balance sheet, then we get the changes in working capital, which then ultimately gives us cash from operating activities. And this is the first section on the statement of cash flows, cash from operating activities.

In the next section on the statement of cash flows is we have cash from investing activities. And the name pretty much says it all. So when we make investments in other companies or other items, those investments are gonna be recorded here in this section on the statement of cash flows.

But what I wanna point out specifically here is Cap-X, which is just a short form of saying capital expenditures. This represents investments in property, plant, and equipment. Remember, the balance sheet is just capturing the balance of certain assets.

So you can't just look at a balance sheet on a given day and look at the property, plant, and equipment balance and record it as Cap-X. Instead, you're only recording the net difference in Cap-X from one period to the next. So if you go out and you buy a $50,000 truck and cash goes out the door for it, it's recorded here in Cap-X.

Now, I interview a lot of CFOs and controllers, and I will often ask them, where do you find Cap-X on the financial statements? Now you know it's on the statement of cash flows under investing activities. So don't miss that question if anybody asks you that. All right, so that's investing activities.

It's cash coming in or out for investments, specifically and especially pertaining to Cap-X because we're gonna come back to this when I show you how to compute free cash flow. The next section is cash from financing activities. And this is just debt and equity financing.

So if you go secure a loan for your business and you draw on that loan, you're gonna have cash coming into the business. If you pay down that debt, you're gonna have cash flowing out of the business. Same thing with equity.

You go raise capital from investors, you're gonna have cash flowing in. You pay dividends or distributions, cash is gonna flow out. So you're just capturing all the cash related to debt and equity transactions here in financing activities.

Then you have the change in cash when you add up these three boxes. So this plus this plus this equals your change in cash. Then you take the beginning cash at the start of the period.

You add these together and you arrive at ending cash. And here's the cool thing. On the balance sheet, right here, this is our balance sheet.

Remember, we already accounted for all the changes in these current assets and current liability accounts. We also accounted for debt down here in financing activities, so we accounted for those changes. And then ultimately, at the top of the balance sheet is we have cash, and this number ties right here to ending cash.

So that's how these financial statements flow together. I have a whole nother video on how to read financial statements. You definitely wanna check that out if you wanna see how these three financial statements come together and how money flows within an organization.

But just to show you here, the income statement plus the balance sheet, imagine these two financial statements fall in love. They have a baby. That baby is called the statement of cash flows because it's a combination of items off the income statement plus items off the balance sheet, which makes up the statement of cash flows.

This is the most important financial statement, like I said, in any business because it'll tell you where cash is flowing in. Now, you may have negative operating cash flow and you may remain in business for a period of time if you have cash coming from these other two buckets, investing and financing activities to make up for the shortfall. But if you are experiencing operating cash losses and you don't have access to financing capital from debt or equity, you're gonna run out of business.

The income statement isn't always gonna tell you that because remember, net income is not cash, so don't fall into that trap. But let me walk you through lastly, how to compute free cash flow. There's the long way.

You could look at the income statement and you take net operating profit after tax. You account for depreciation and amortization by adding it back. You take into account changes in networking capital and then capex, and then you arrive at free cash flow.

But the shortcut is you just go to the statement of cash flows, take cash from operating activities, so free cash flow, can't even spell here, free cash flow, or abbreviate rather. Free cash flow is operating cash less capex. That's the formula here.

So just take cash from operating activities, subtract out capex, and you'll arrive at free cash flow of the business. Why is this important? Because this is the money that a company spends off and that's available to return to equity investors through distributions or dividends, or it's money available to pay down debt to give back to debt providers, or you could take this cash and reinvest it back in the business to strengthen the organization for the long term and to build a really viable company, a company that's super resilient. So the most successful businesses out there are those that produce healthy free cash flow, not those that have a giant top line or a bunch of net income, but those that have free cash flow because you may have a bunch of net income, but if a lot of your money is tied up in working capital, or you have to reinvest that net income in property, plant, and equipment, also known as capex, then look, you may be pouring all that cash back into the business just to sustain operations.

All right, what else do you wanna learn? How else can I help you? Please provide comments down below and just share with me what topics are you most interested in so when I'm planning out the content that I'm gonna create into the future, I can deliver specific and unique value directly towards you, okay? So that's my big ask there, make sure you engage, leave your comments down below, and subscribe so you get notified every time I drop a new video like this one. And in the meantime, take care of yourself. Cheers.