If you have read the first two postings in this series, you know what the balance sheet] and [income statement][2 say about a business. These two pieces do not tell the whole story. For that you need the cash flow statement. Why? Because you can’t buy groceries with inventory and you can’t buy gas with net income. Cash is like blood to a business - without enough even the healthiest business will come to a screeching halt.

The cash flow statement has three main components corresponding to the three sources of cash: Operations, Investment and Financing.

Cash Flow From Operations The first classification of cash flow comes from operations. The components are:

• Net Profit - From the Income Statement.
• Depreciation - This was subtracted from Revenue in the Income Statement, but it is not a cash cost. It is therefore added back to Operating Cash Flow.
• Change in Inventory - If inventory increases, the business must spend cash to pay for this. If it decreases, it returns cash back the business.
• Change in Accounts Receivable - Accounts receivable are bills owed to you from your clients. Like inventory, an increase will detract from cash flow. A reduction will return cash.
• Change in Accounts Payable - Accounts payable are bills you owe to your suppliers. This is like a line of credit that you get from your suppliers. Like inventory, an increase will contribute to cash flow. A reduction will reduce cash.

A normally operating business will have a positive operating cash flow. A business with a negative operating cash flow is either in a period of rapid expansion or in serious trouble.

Cash Flow From Investing This is the section where a company buys or sells it’s assets. This is negative when buying because buying is a use of cash. It is positive when selling the assets. When these assets are bought or sold, the adjustments are made on the assets side of the balance sheet.

Cash Flow From Financing Equity and debt financing make up this portion of the statement.

Equity financing comes into the business in the form of stock sales. Equity financing leaves the business in the form of dividend payments. Any equity financing coming into or out of the business is recorded here as well as the equity side of the balance sheet.

Debt financing comes into the business in the form of bonds, mortgages, lines of credit, capital leases, etc. It leaves in the form of bond maturities, mortgage payments, lease payments and operating line repayments. These are accounted for on balance sheet’s liabilities section.

Cash flow from financing is typically positive when the business starts and when it is expanding. If the business is at a steady state, financing cash flow is positive, as the bank gets its loan paid back and owners receive dividend payments.

When the three cash flows are added up, we get the net cash flow for the company. This total is added or subtracted to the cash total on the previous year’s balance sheet. Now that the three pieces are described, tune in tomorrow to see how they all fit together.