Cash Flow Statement: A Real Testimony of the Performance.

When it comes to financial statements, most people primarily focus on the Profit & Loss account and Balance sheet. The profit & Loss statement reflects business performance over a period, while the Balance Sheet shows the financial position of the company, including liquidity, solvency, and the company's ability to continue as a going concern.

As a result, the Cash flow statement, though a mandatory part of the financial statement, is often overlooked. Many fail to realize that it provides critical insights into how cash is moving in and out of the business, which can differ significantly from accounting profits.

What is a cash flow statement, and why is it important?

As we all know, financial statements like the Profit & Loss Account and Balance Sheet are prepared based on the accrual concept, not based on the actual cash movement. This means the Profit & Loss Account does not reveal how much real cash came into or went out of the business. It does not answer key questions like:

• Was the cash generated from core operations enough to sustain the business?
• Was external funding or debt required to bridge gaps?
• Were profits merely on paper, or backed by cash inflows?

This is where the Cash Flow Statement becomes invaluable - it provides the missing link between profitability and liquidity.

How do you prepare the Cash flow statement?

As recognized by international accounting frameworks, it is a standardized accounting principle that cash flow can be prepared using two methods - the Direct method & indirect Method.

Direct Method

In the direct method, actual cash transactions are listed - such as cash received from customers, cash paid to suppliers, cash paid for expenses, etc. This method shows cash inflows and outflows directly, without starting from net profit.

Indirect Method

In the indirect method, the starting point is the net profit as per the Profit & Loss account. Then, all non-cash items (like depreciation, amortization) and changes in working capital (current assets and current liabilities) are adjusted to arrive at net cash flow from operating activities.

Structure of the cash flow statement

Cash flow statement can be divided into three parts as below:

1. Cash flows from operating activities.
2. Cash flows from investing activities.
3. Cash flows from financial activities.

Cash flow from operating activities.

This section shows the cash inflows and outflows from the core operations of the business. For a business to sustain and scale, it must generate not just profits, but actual cash from operating activities. Consistent cash generation from operations is a strong indicator of a healthy and self-sustaining business.

If cash flow from operating activities remains negative consistently, it signals a serious liquidity concern - even if the business is showing profits on paper. This gap indicates that profits aren't translating into actual cash, which can affect the company's ability to meet day-to-day obligations.

Cash flow from investing activities.

This section shows how the company is deploying cash for long-term growth - such as purchasing fixed assets, investing in new projects, or pursuing acquisitions and mergers (M&A). These outflows indicate whether the business is investing strategically in future scalability and expansion.

Similarly, this section also conveys cash inflow from the sale of fixed assets, the sale of investments, and repayment of loans.

Cash flow from financing activities

Cash inflows such as raising equity capital or securing debt through bank loans, bonds, or debentures are part of cash flow from financing activities.

Similarly, cash outflows like loan repayments, share buybacks, and dividend payments also fall under this section.

Cash flow from financing activities helps assess whether the business is:

• Relying on external funds to survive or grow
• Managing its debt obligations wisely
• Rewarding its shareholders

What cash flow reveals about your business that profit & Loss don't

The Profit & Loss account shows the profit generated from business operations during a given period. However, a positive profit alone is not always a sign of strong performance.

For instance, if a large portion of your sales is on credit and the cash conversion cycle is long, the business may struggle with liquidity, despite showing accounting profits. Worse, if those credit sales turn into bad debts, it can lead to serious financial stress.

That's why the real test of a business's financial health is whether it is generating positive cash flow from operating activities. This reflects the actual cash the business generates from its core operations.

Consistent negative operating cash flow is a warning sign. It suggests problems in the business model - poor collection cycles, high overheads, or unprofitable operations.

Moreover, when operating cash flow is negative, you'll often see more activity in the financing section of the cash flow statement - such as taking more loans or raising capital. This shows the business is relying on external funds to survive rather than funding itself through internal cash generation.

Key Takeaways of an Ideal Cash Flow Statement:

• Cash Flow from Operations should be strongly positive - shows the core business is healthy.
• Cash Flow from investing may be negative - indicates investment in long-term assets.
• Cash Flow from financing should be stable - Not meant to cover up operational losses.
• Net cash should grow over time or be stable based on the business cycle.

How to use Cash Flow Statements for better decisions:

Prioritize Operating Cash Flow Over Net Profit

Net profit can be "accounting-driven"; cash flow from operations (CFO) is reality.

Use it to assess true business sustainability and working capital efficiency.

Use Free Cash Flow to Measure Financial Strength

Free Cash Flow (FCF) = Cash Flow from Operations - Capital Expenditure.

Use it to decide whether you can fund expansion, pay dividends, or reduce debt without borrowing.

Analyze Patterns, Not Just Numbers

Look beyond one-time inflows/outflows.

Use it to identify trends in receivables, payables, or cyclical cash strains - helpful for cash flow forecasting.

Link Cash Flow to Strategic Planning

Align cash inflows/outflows with business milestones.

Use it to time investments, new hires, or debt repayments with real liquidity rather than assumptions.

Monitor Financing Cash Flow for Risk Signals

Consistent cash inflow from financing = Red Flag.

Use it to check whether you're dependent on debt or equity to survive, and whether that's scalable.

Use Scenario-Based Cash Flow Modeling

Simulate best, base, and worst-case cash flow situations.

Use it to prepare for liquidity shocks, slowdowns, or funding delays.

Cash Flow as a Governance Tool

Tie cash metrics to performance KPIs.

Use it to build discipline in budgeting, capital allocation, and treasury decisions.

Optimize Cash Conversion Cycle (CCC)

Measure how quickly you convert investments in inventory and receivables into cash.

Use it to improve pricing terms, vendor negotiations, or credit control strategies.

Integrate Cash Flow in Valuation and Exit Planning

Investors and acquirers care more about predictable cash flows than past profits.

Use it to enhance your valuation story and exit readiness.

Conclusion

Surely, a profitable business is a strong indicator of growth potential. However, it is equally - if not more - important to assess the business in terms of real cash generation, because cash is king.

The future is uncertain, and market conditions may not always remain favorable. Disruptive innovations or external shocks can quickly derail even seemingly strong businesses. In such situations, only businesses with consistent, positive cash flows have the resilience to survive and adapt.

A robust cash flow built over time acts as a financial buffer, giving the business confidence and flexibility to navigate tough times, invest wisely, and sustain long-term performance.