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Lesson 6 of 6Financial Analysis and Decision Making
Unit 4 · Lesson 6 of 6

The Cash Flow Statement

The cash flow statement explains why cash changed during the year by sorting every cash receipt and payment into operating, investing and financing activities, with operating cash flow usually found by adjusting net income (the indirect method), and the net change must reconcile to the balance sheet.

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Key things to remember

  1. 1Net income is not cash: accruals, amortization and capital purchases make them differ.
  2. 2Indirect method: net income amortization losses gains increases in current assets decreases in current assets increases in current liabilities decreases in current liabilities.
  3. 3Investing activities: buying and selling long-term assets and investments. Financing: borrowing, repaying, issuing shares, paying dividends.
  4. 4Operating investing financing net change in cash, which must equal ending cash minus beginning cash on the balance sheet.
  5. 5Positive operating and negative investing cash flow usually signals a healthy, growing company.

Maple Outdoor earned $75,000 of profit in 2026, yet its bank balance rose by only $10,000. Where did the rest go? Profit is not cash. Under accrual accounting, revenue is recorded when it is earned (even if the customer has not paid), expenses are recorded when they are incurred (even if the bill is unpaid), and a $92,000 equipment purchase appears on the income statement only gradually, as amortization. Plenty of profitable businesses have failed because they ran out of cash. The cash flow statement (older texts call it the statement of changes in financial position) explains exactly how cash went from its opening to its closing balance.

OperatingCash from customersCash paid to suppliersWages paidInvestingPurchase of equipmentSale of landPurchase of investmentsFinancingOwner investmentBank loan proceedsOwner withdrawalsOpening Cash Balance+ Net Change in Cash= Closing Cash Balance
Fig 1Every cash receipt and payment falls into one of three activities: operating, investing or financing.

Three kinds of activity

ActivityWhat it coversTypical inflowsTypical outflows
OperatingThe day-to-day business that produces net income; mostly current assets and current liabilities.Cash from customersPayments to suppliers and employees, interest, income tax
InvestingBuying and selling long-term assets and investments.Sale of equipment, land or investmentsPurchase of property, plant and equipment or investments
FinancingDealings with lenders and owners; long-term liabilities and equity.Borrowing; issuing sharesRepaying loans; buying back shares; paying dividends
Classification under ASPE. Under IFRS, interest and dividends paid may be classified as operating or financing, applied consistently.

Operating activities by the indirect method

Most companies report operating activities by the indirect method: start with net income and adjust it for every item that affected profit but not cash, or cash but not profit. There are three kinds of adjustment. First, add back non-cash expenses such as amortization, which reduced profit but required no payment this year. Second, remove gains and losses on disposals of long-term assets: a loss is added back and a gain is subtracted, because the full cash from the sale is reported in investing activities. Third, adjust for changes in non-cash current assets and current liabilities.

Riverside Retail Inc.Cash Flow StatementYear Ended December 31, 2026Operating activitiesNet income60 000Adjustments:Amortization expense15 000Increase in accounts receivable(8 000)Decrease in inventory5 000Increase in accounts payable4 000Decrease in wages payable(2 000)Net cash from operating activities74 000Investing activitiesPurchase of equipment(50 000)Proceeds from sale of land10 000Net cash used in investing activities(40 000)Financing activitiesIssued common shares20 000Repaid bank loan(15 000)Dividends paid(12 000)Net cash used in financing activities(7 000)Net increase in cash27 000Cash, January 118 000Cash, December 3145 000Indirect method rulesStart with net income+ amortization (no cash left)Current asset ↑ → subtractCurrent asset ↓ → addCurrent liability ↑ → addCurrent liability ↓ → subtractGain on sale → subtractLoss on sale → addReconcileNet change 74 000 −40 000 − 7 000 = 27 000.18 000 + 27 000 = 45 000,the Cash on the Dec 31balance sheet.Brackets( ) means cash going out,or a subtraction.
Fig 2The indirect method starts at net income, adds back non-cash expenses, removes gains and losses, and adjusts for changes in working capital.
Change during the yearAdjustment to net incomeWhy
Current asset increases (e.g. accounts receivable up)SubtractSales were recorded but not all collected, so cash is lower than profit.
Current asset decreases (e.g. prepaid expenses down)AddAn expense was recorded this year that was paid for last year.
Current liability increases (e.g. accounts payable up)AddExpenses were recorded but not yet paid, so cash is higher than profit.
Current liability decreases (e.g. accrued liabilities down)SubtractCash paid this year settled last year's expenses.
The working-capital rule: assets move opposite to cash; liabilities move with cash. Cash itself is excluded.
VideoStarts from net income, adds back amortization (he says depreciation), then adjusts for changes in current assets and liabilities, the same steps this lesson uses.Watch on YouTube

A complete statement that reconciles

Here is Maple Outdoor Ltd.'s 2026 cash flow statement, built from its comparative balance sheet and income statement. Extra information: amortization expense was $30,000; no equipment was sold, so equipment purchased the company borrowed $25,000 more long-term debt; it issued 5,000 common shares for $20,000; and dividends declared and paid were

Maple Outdoor Ltd. Cash Flow Statement, year ended December 31, 2026
Operating activities
Net income$75,000
Add: Amortization expense$30,000
Increase in accounts receivable($10,000)
Increase in inventory($20,000)
Decrease in prepaid expenses$2,000
Increase in accounts payable$10,000
Decrease in accrued liabilities($5,000)
Net cash provided by operating activities$82,000
Investing activities
Purchase of equipment($92,000)
Net cash used by investing activities($92,000)
Financing activities
Proceeds from long-term debt$25,000
Proceeds from issuing common shares$20,000
Dividends paid($25,000)
Net cash provided by financing activities$20,000
Net increase in cash$10,000
Cash, January 1, 2026$30,000
Cash, December 31, 2026$40,000
The ending cash of $40,000 agrees with the December 31, 2026 balance sheet, so the statement reconciles.
The reconciliation check
Operating + investing + financing = net change in cash. Here 82,000 - 92,000 + 20,000 = 10,000, and opening cash of 30,000 plus 10,000 equals the 40,000 on the balance sheet. If your statement does not land exactly on the balance-sheet cash, a change has been missed or given the wrong sign.

Interpreting cash flow patterns

OperatingInvestingFinancingTypical story
+-- or small +Healthy, growing company: operations fund new assets, with cash left to repay debt or pay dividends.
+-+Expanding quickly: operations plus new borrowing or shares fund heavy investment (Maple's pattern).
--+Start-up or struggling company: it relies on lenders and investors to cover both operations and investment.
-++ or -Distressed: selling long-term assets to survive.
++-Mature or shrinking: selling assets and using operating cash to repay debt or reward shareholders.
Signs of the three subtotals and what they usually suggest. Always confirm with the MD&A.

Using spreadsheets for financial analysis

Analysts rarely compute ratios and cash flow statements by hand. A spreadsheet holds two years of statements in columns, and formulas do the rest; change one number and every ratio and subtotal updates. Put each statement item in its own row (for example, 2026 in column B and 2025 in column C), then write each calculation once. Use ROUND to match a stated rounding, and an absolute reference such as $B$20 when every formula in a column must divide by the same base (for example, net sales in vertical analysis). Build in a check cell that compares the cash flow statement's ending cash with the balance sheet's cash and shows TRUE only when they agree. Accounting software and data tools can also chart trends and pull comparable companies' figures, but the analyst still has to choose the right formula and interpret the result.

B4  Current assets            250000
B5  Current liabilities       110000
B6  Current ratio             =ROUND(B4/B5, 2)            -> 2.27
D8  % change in sales         =ROUND((B8-C8)/C8*100, 1)   -> 14.3
E9  Common-size COGS (%)      =ROUND(B9/$B$8*100, 1)      -> 60.0
B30 Cash from operations      =SUM(B22:B29)               -> 82000
B34 Net change in cash        =B30+B32+B33                -> 10000
B36 Check                     =B35+B34=B37                -> TRUE
Sample spreadsheet formulas for ratios, horizontal and vertical analysis, and the cash flow check.

Worked examples

Reveal one step at a time and try to beat it to the next line.

Example 1
Prepare the operating activities section (indirect method) for Pine Ridge Supply Ltd.: net income $60,000; amortization $18,000; gain on sale of equipment $3,000; accounts receivable decreased $5,000; inventory increased $12,000; accounts payable decreased $4,000; income tax payable increased $1,000.
Example 2
Continue Pine Ridge Supply: it sold equipment with a book value of $7,000 for $10,000 cash (the $3,000 gain), bought new equipment for $50,000 cash, repaid $20,000 of a bank loan and paid $15,000 of dividends. Opening cash was $32,000. Complete the statement and find ending cash.
Example 3
Classify each item and state whether it is an inflow or outflow: (a) bought land for cash; (b) issued common shares; (c) paid dividends; (d) increase in accounts payable; (e) sold a long-term investment; (f) repaid a mortgage.

Where marks get lost

  • Reversing the working-capital signs: an increase in a current asset is subtracted, not added.
  • Including the change in cash itself as one of the working-capital adjustments.
  • Reporting the gain on a sale as the investing inflow instead of the full cash proceeds, or forgetting to subtract the gain in operating activities, which counts it twice.
  • Putting dividends paid in operating activities under ASPE, or treating the declaration of a dividend not yet paid as a cash outflow.
  • Forgetting to check that the net change in cash reconciles to the balance sheet.

Flashcards 8

Indirect method
Why add back amortization?
Gain on sale in the indirect method
Increase in accounts receivable
+ 4 more

Practice

1
Net income is $48,000; amortization is $12,000; accounts receivable increased $6,000; accounts payable increased $4,000. What is cash provided by operating activities? Answer to the nearest dollar.
$
2
Net income is $90,000, amortization is $25,000 and there was a $7,000 loss on the sale of equipment. Inventory decreased $8,000 and accrued liabilities decreased $3,000. What is cash provided by operating activities? Answer to the nearest dollar.
$
3
Operating activities provided $70,000, investing used $95,000 and financing provided $40,000. Opening cash was $18,000. What is ending cash? Answer to the nearest dollar.
$
4
Equipment with a book value of $14,000 was sold at a $2,500 loss. How much cash is reported as an investing inflow? Answer to the nearest dollar.
$
5
Match each transaction to its section of the cash flow statement.
Purchased a delivery truck for cash
Issued bonds at face value
Amortization expense
Paid dividends (ASPE)
Sold a long-term investment
6
During the year, accounts receivable increased by $15,000. How is this shown under the indirect method?
7
A company shows negative operating cash flow, negative investing cash flow and large positive financing cash flow. What does this pattern most often indicate?
8
Put the main sections of a cash flow statement in the order they appear.
  1. 1Cash at end of year
  2. 2Net change in cash
  3. 3Financing activities
  4. 4Operating activities
  5. 5Investing activities
9
What is the older name for the cash flow statement?
10
In a spreadsheet, you want every common-size income statement formula in column D to divide by net sales in cell B5. Which reference should the formulas use for B5?

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