How to Complete a Cash Flow Statement from the Income Statement and Balance Sheet

In this article, we’ll go over how to complete a cash flow statement from the income statement and balance sheet and how to analyze and interpret the cash flow statement.

In accounting, the balance sheet, income statement, and cash flow statement are referred to as the “three statements.”

Let’s go through each individually:

Balance Sheet

On the balance sheet, we have three things – assets, liabilities, and shareholder’s equity, with assets being equal to the sum of liabilities and shareholder’s equity.

Assets

Assets include items such as:

• Cash and cash equivalents
• Accounts receivable
• Inventories
• Plant, property, and equipment (PP&E)
• Intangible assets and goodwill
• Deferred taxes
• Any long-term assets

Liabilities

Liabilities include:

• Accounts payable
• Notes payable
• Current portion of long-term debt
• Long-term debt
• Deferred taxes

Shareholders’ equity

Shareholders’ equity items include:

• Preferred stock
• Common stock par value
• Additional paid-in capital
• Treasury stock
• Retained earnings

Many company balance sheets will also have sub-charts on the bottom where beginning-of-period and end-of-period items, such as PP&E and intangibles assets and goodwill, can be displayed further (e.g., how capital expenditures affected PP&E between two dates).

The balance sheet is often referred to as a “snapshot” of a company’s financials given it is not accrual-based but rather based on a reading at a singular point in time.

The income statement, on the other hand, covers a particular time horizon, such as a quarter or a year, on an accrual (additive) basis.

In other words, the income statement tracks all revenue and all expenses over the course of a quarter or year.

The balance sheet will just look at what certain accounts read at a given point in time. For example, if a company’s quarter ended on December 31, they’ll report what their cash balance, accounts receivable, and so on were on that particular day.

How a balance sheet appears will depend on the company.

There are various additional items and sub-items that can be included, but these are mainly what you will tend to see and represents the fundamentals.

This article is designed to be more educational than illustrative of a specific company analysis, so it mainly goes on a case-by-case basis.

Income Statement

The income statement is formed from revenues and expenses, including write-offs (e.g., depreciation and amortization, taxes) accrued throughout the time period considered.

The income statement takes into account the following:

• Net revenues
• Cost of goods sold (COGS)
• Selling, general, and administrative (SG&A)
• Research and development (R&D)
• Depreciation and amortization (D&A)
• Other operating expenses
• Net interest expense
• Pre-tax income
• Income tax expense
• Net income
• Dividends

Pre-tax income is net revenues minus all items following (COGS, SG&A, R&D, D&A, other operating expenses, and net interest expense).

Net income is pre-tax income minus income tax expense.

Earnings per share (EPS) is also regularly included on an income statement given how significant the metric is to investors.

EPS is determined by the following formula:

EPS = (Net income – preferred stock dividends) / # of Fully Diluted Shares Outstanding

An income statement can help investors determine the recent financial performance of the company, its future performance, and its potential to generate cash flow.

However, it does not say anything about the value of a brand name or patents associated with the company, which is not outwardly assessed despite their impact.

For example, we know that Nike can sell shoes based on their brand name alone, given they’re a known commodity going back decades. The same holds true for Apple and its smartphone, computers, tablets, and other products.

People come to trust a brand and that has real economic value even if it’s not always outwardly measured.

Cash Flow Statement

The cash flow statement represents the inflow and outflow of cash with respect to the firm and is comprised of three parts:

• Cash from operations
• Cash from investing
• Cash from financing

Finding these values is based on some basic arithmetic from the balance sheet and income statement.

Cash flow from operations

Cash from operations is the sum of the following items:

• Net income
• Depreciation and amortization
• Changes in working capital (accounts receivable, inventories, accounts payable)
• Deferred taxes

Net income and depreciation and amortization

Net income and depreciation and amortization can be taken directly from the income statement.

Changes in working capital

Changes in working capital is a combination of accounts receivable, inventories, and accounts payable.

Accounts receivable

Accounts receivable – often abbreviated A/R or simply AR – is a balance sheet item.

We take accounts receivable from the beginning of the period minus accounts receivable at the end of the period.

As a general rule, when doing arithmetic for the cash flow statement with respect to assets, we take the beginning of the period balance and subtract the end of the period balance. That means if an asset increases in value it represents a negative cash flow item.

This should make intuitive sense given that if we an increase an asset, we must use cash in order to do so.

Inventories

Inventories is also an asset so we follow the same procedure – beginning of period balance minus the end of period balance.

Accounts payable

For accounts payable – often abbreviated A/P or simply AP – this is a liability so we reverse the process given any increase represents a cash inflow.

Deferred taxes

Deferred taxes is a combination of both assets and liabilities.

For deferred taxes rooted in the assets part of the balance sheet, we start with the beginning of period balance and subtract the end of period balance.

For deferred taxes in the liabilities portion, we do the the opposite, starting with the end of period balance and subtracting the beginning of period balance.

When we sum up net income, depreciation and amortization, changes in working capital and deferred taxes, we arrive at cash flow from operations.

Cash flow from investing

Cash from investing is the sum of the following items:

• Capital expenditures (capex)
• Increase in all other long-term assets

Capex

Capex can be pulled directly from the balance sheet.

We must remember to make it negative given that capex is inherently about spending on new assets, which is a cash expenditure as its full name might suggest.

Increase in long-term assets

Increase in all other long-term assets is taken from the assets portion of the balance sheet, so we start with beginning of the period balance and subtract the end of period figure.

We also need to deduct columns that say “new purchases” as this also represents a cash outlay.

Cash flow from financing

Cash from financing is the most involved of the three as we need the following seven items:

• Increase in bank loan
• Increase in long-term debt (often abbreviated LTD)
• Increase in preferred stock
• Increase in common stock
• Increase in APIC
• Increase in Treasury stock
• Dividends

Increase in bank loan

Increase in bank loan can be traceable to the notes payable entry on the liabilities portion of the balance sheet.

As a liability, we begin with the end of period balance and subtract the beginning of period value.

Increase in long-term debt (LTD)

Increase in long-term debt (LTD) comes from two entries: current portion of long-term debt and long-term debt, both situated in the liabilities column.

We subtract the end of period balance from the beginning of period balance from each component and add the two together.

Increase in preferred stock

Increase in preferred stock is a shareholder’s equity item.

The arithmetic here follows the same logic as in the liabilities portion of the balance sheet.

We take the end of period balance and subtract the beginning of period balance.

An easy way to remember this is through the fact that assets must always be equal to the sum of liabilities plus shareholder’s equity.

Thus liabilities and shareholder’s equity follow the same format as cash inflows (when they increase) while assets are comprised of cash outflows (when they decrease).

(Note that a main component of shareholder’s equity – retained earnings – is equal to: Retained earnings from beginning of the time period + Net income – Dividends)

Increase in common stock

Increase in common stock comes from the common stock par value entry from the shareholder’s equity part of the balance sheet, subtracting end balance from beginning balance.

Increase in APIC

Increase in APIC (additional paid-in capital) is also part of shareholder’s equity.

It represents the amount of capital that investors paid above the par value of a stock price.

For example, if a 1,000 shares of stock were released by a company for $30 per share and investors paid $45 dollars for those shares, then the APIC would be equal to:

($45 – $30) * 1,000 = $15,000

This figure would positively add to cash flow.

Increase in treasury stock

Increase in treasury stock is added to cash flow from financing by taking its end of period balance and subtracting its beginning of period balance.

Dividends

Dividends is taken directly from the income statement. Any dividends paid out comprise a negative cash item given it is an outflow paid to investors.

The sum of these elements provide cash from financing.

Total cash balance

To find our total cash balance, we must add the total change in cash balance to the beginning cash balance.

Beginning cash balance can be found directly on the balance sheet under assets, as “cash and cash equivalents” from the beginning of the time period. It is typically the first item provided.

To find total change in cash balance, we must sum together the three components of the cash flow statement:

• cash flow from operations
• cash flow from investing, and
• cash flow from financing

Added to beginning cash balance, and we have total cash balance from the time period.

Conclusion

The cash flow statement provides a general picture of the funds flowing in and out of a business.

Notably, it gives investors and prospective investors insight into how well a company can reliably pay down its debts.

Items from the other two financial statements – the balance sheet and income statement – work together to provide a look at how these inputs affect cash and its equivalent forms and break them down into cash flow sub-categories (operating, investing, and financing activities).

Cash flow is then calculated from the sum of these three categories.

Cash flow items are often vital inputs into various financial models in order to value companies and hence has a significant role in valuation analysis.