Use Our Resources and Tools to Get Started With Your Preparation!

Learn the case interview basics, practice with 200+ cases, and benefit from extensive test materials, and interactive self-study tools.
Previous article
Next article

The cash flow statement gives an overview of a firm’s ability to generate cash

The cash flow statement belongs to one of the three financial statements in addition to the balance sheet and income statement. Cash flow statements show the inflow/outflow of cash. The key difference between a cash flow statement and an income statement is that while an item gets listed in the income statement as soon as it is accrued, the same item gets listed in the cash-flow statement only after the actual payment has happened.

Cash flows can be segmented into three major categories:

  • Operating cash flows are a result of the core business in which cash flows are directly generated by manufacturing or selling a product. These are necessary to keep the business operating.
  • Investment cash flows are long-term investments into assets such as property or plants.
  • Financing cash flows are a result of activities such as issuance and repurchase of bonds, equity, and dividends.

Cash flow, balance sheet, and financial statement are interdependent

The income statement is used to derive the operating cash flow:

  • In general, you start with EBIT. All included positions that have no actual influence on cash flows are subtracted. For example: to derive the earnings before interest and taxes (EBIT), depreciation is subtracted from the gross profit. Since depreciation is not actual cash flow, it has to be added again to get a true picture of a firm’s cash flow.  Likewise, positions that are not included in EBIT, but result in changes in cash flow need to be added, e.g. taxes.

The balance sheets from two consecutive years are used to derive the investment and financing cash flow:

  • Determine the investment cash flow over the asset side of the balance sheet: If assets increase due to investments over the past year, cash-outflows are necessary to acquire them. Likewise, if assets such as inventory decrease, they result in cash inflows from sales.
  • Use the financing side of the balance sheet to derive the financing cash flow. If equity or liabilities increase a cash inflow must have happened. Of course, you can buy assets immediately through debts meaning that the cash from getting credit is directly used for the asset. Consequently, cash flows possibly cancel each other out.

The sum of all three cash flows (operating, investment and financing) is the final change in cash. You can find this change in the balance sheet as the difference in cash positions between the current and preceding year.

Find below an example of how these three cash flow types can be indirectly calculated

 

type-conversion-1677685075-3hehkdd2cvgo.webp

Cash flows are major inputs for company valuations

Free cash flow is another type of cash flow important for investors. It depicts the amount of cash that can flow to a company’s security holders in terms of dividends or interests without extracting necessary money for daily operations. Free cash flows are often used to determine the company value by applying discounting principles.

Calculations can be done in several different ways. But the key idea remains the same: from a company’s income, add everything that has been subtracted during profit and loss calculation that has no real influence on the level of cash. Subtract everything that is needed as an investment to keep the business running at a current level. This is usually working capital, or current receivables, payables, and capital expenditure  (e.g., investments in plants, property, and equipment), which have to be renewed.

 

type-conversion-1677685100-9bpik3ho1bte.webp

Key takeaways

  • Cash flows are crucial to determine liquidity. Positive cash flows are a sign of at least short-term solvency.
  • Cash flow emerges from operations, investing, and financing.
  • Operating cash flows help to assess the company's ability to fund the ongoing business.
  • Cash flow from investing helps to assess the possibilities of future growth through investments.
Previous article
Next article
Do you have questions on this article?
Contribute to our Q&A forum and ask the community your question!

Related Cases

Dein Klient ist ein spezialisierter Lösungsanbieter für komplexe Leichtbaugruppen aus Metall für die Automobil-, Luft- und Raumfahrtindustrie.Im vergangenen Jahr wurde erstmals ein negatives Betriebsergebnis erwirtschaftet. Die Geschäftsführung beauftragt Dich, ein realistisches Zielbild für Phoenix ... Dein Klient ist ein spezialisierter Lösungsanbieter für komplexe Leichtbaugruppen aus Metall für die Automobil-, Luft- und Raumfahrtindustrie.Im vergangenen Jahr wurde erstmals ein negatives ... (Open whole case)
13.2k
Times solved
3.4
< 100 Ratings
Intermediate
Difficulty
Expert case by Jonas
A medium sized butchery company from the US with a limited product portfolio has experienced declining profits in the last years.Advise the CEO on where the problem comes from and develop solutions to improve his situation. A medium sized butchery company from the US with a limited product portfolio has experienced declining profits in the last years.Advise the CEO on where the problem comes from and develop solutions to improve his situation. (Open whole case)
3.5k
Times solved
3.0
< 100 Ratings
Intermediate
Difficulty
How likely are you to recommend us to a friend or fellow student?
0 = Not likely
10 = Very likely
You are a true consultant! Thank you for consulting us on how to make PrepLounge even better!