💸 Cash Flow Statement

Definition: A financial statement that shows how cash moves into and out of a business over a period of time, classified into operating, investing, and financing activities. Cash is king — net income can be manipulated, but cash flows are harder to fake.

The most important of the three financial statements for credit analysis and DCF valuation.

---

🔑 Why Cash Flow ≠ Net Income

Accrual accounting lets companies record revenue when earned (not received) and expenses when incurred (not paid). This creates a gap:

Scenario	Net Income impact	Cash impact
Sell on credit ($100K)	Revenue recognized now	Cash comes later
Buy inventory ($50K)	No P&L impact yet	Cash gone now
Depreciate equipment ($20K)	P&E expense recognized	No cash leaves
Receive advance payment ($30K)	No revenue yet	Cash in now

Result: A company can be profitable but cash-flow negative (growing fast, bad collections) or lack income but cash-flow positive (asset sales, depreciation-heavy). Always read both.

---

📐 Three Sections of the Cash Flow Statement

─────────────────────────────────────────
A. OPERATING ACTIVITIES
   Net Income                       +
   + Depreciation & Amortization    +  (non-cash add-back)
   + Changes in Working Capital:
       Δ Accounts Receivable         − (increasing AR uses cash)
       Δ Inventory                   − (increasing inventory uses cash)
       Δ Accounts Payable            + (increasing AP = cash cushion)
─────────────────────────────────────────
= Cash from Operations (CFO)

B. INVESTING ACTIVITIES
   Capital Expenditures (CapEx)      − (buying PP&E)
   Acquisitions                      −
   Asset sales                       +
   Purchase of investments           −
─────────────────────────────────────────
= Cash from Investing (CFI)         [Usually negative for growing companies]

C. FINANCING ACTIVITIES
   Debt issuance                     +
   Debt repayment                    −
   Stock issuance                    +
   Share buybacks                    −
   Dividends paid                    −
─────────────────────────────────────────
= Cash from Financing (CFF)

NET CHANGE IN CASH = CFO + CFI + CFF

---

🔢 Key Cash Flow Metrics

Free Cash Flow (FCF) — The Core Valuation Input

$\text{FCF}=\text{Cash from Operations}-\text{Capital Expenditures (CapEx)}$

FCF represents the actual cash the business generates — available for debt repayment, dividends, buybacks, or acquisitions.

Alternative formula (used in DCF): $\text{FCFF}=\text{EBIT}\times (1-t)+D\&A-\Delta \text{Working Capital}-\text{CapEx}$

CapEx Types

• Maintenance CapEx: Just keeping existing assets running
• Growth CapEx: Investing for future revenue growth

Warren Buffett’s “Owner Earnings” = Net Income + D&A − Maintenance CapEx

---

📊 Signs of Quality Cash Flow

Good Sign	Bad Sign
CFO consistently > Net Income	CFO < Net Income (aggressive revenue recognition)
Growing FCF over time	Negative FCF + no path to profitability
Low CapEx intensity (high FCF conversion)	CapEx-heavy with thin margins
Working capital needs declining	AR growing faster than revenue
Financing from operations, not debt	Funding operations with constant debt issuance

---

🏆 Cash Flow in Valuation

DCF Valuation is built entirely on projected unlevered FCF:

$\text{Enterprise Value}={\sum }_{t=1}^n\frac{FC{F}_t}{(1+WACC{)}^t}+\frac{\text{Terminal Value}}{(1+WACC{)}^n}$

The CFO → FCF → DCF chain: Understanding cash flow statements is the prerequisite for DCF modeling.

---

🔗 Connected Concepts

• Income Statement — Net income is the starting point of the cash flow statement
• Balance Sheet — Cash is an asset; statement reconciles beginning and ending cash
• DCF Valuation — FCF is the key input
• WACC — FCF discounted at WACC to get enterprise value
• Working Capital Management — Working capital changes are major cash flow drivers

---

← 📒 Accounting MOC | Related: Income Statement · Balance Sheet · DCF Valuation