Guides
The Cash Flow Statement Explained, With an Example
A cash flow statement is the financial report that tracks the actual cash moving into and out of a business over a period, sorted into three sections: operating, investing, and financing activities. It reconciles a company’s accrual-basis profit to the change in its cash balance, answering a question the income statement cannot: did the business actually generate cash? Under U.S. GAAP, it is one of the required primary financial statements.
The statement of cash flows sits alongside the income statement and balance sheet as the third core financial statement. A company can report positive net income and still run out of cash, because revenue is booked when earned, not when collected. The cash flow statement closes that gap by showing where cash came from and where it went.
What the cash flow statement shows
The cash flow statement shows the change in a company’s cash and cash equivalents over a reporting period, broken into operating, investing, and financing activities. It starts with a beginning cash balance, adds or subtracts the net cash from each of the three sections, and arrives at the ending cash balance, which ties directly to the cash line on the balance sheet.
The statement is required under FASB ASC 230, the accounting standard governing the statement of cash flows. ASC 230 requires the statement for each period an income statement is presented. The purpose, per the standard, is to give users information to assess a company’s ability to generate cash, meet obligations, and fund operations.
Because it reports cash rather than accruals, the statement is harder to manipulate than reported earnings. Analysts often compare cash flow from operations to net income: when operating cash flow lags profit for several periods, it can signal aggressive revenue recognition or a working capital problem.
The three sections of the cash flow statement
The cash flow statement splits every cash movement into three categories: operating activities (the core business), investing activities (buying and selling long-term assets), and financing activities (raising and returning capital). Each section nets to a subtotal, and the three subtotals combine to equal the net change in cash for the period.
Cash flow from operating activities
Operating activities cover the cash effects of the transactions that produce net income: cash from customers, payments to suppliers and employees, interest, and taxes. This section is often the most watched, because a healthy company usually funds itself from operations rather than from borrowing or selling assets. It can be presented using the direct or the indirect method.
Under U.S. GAAP, interest paid, interest received, and dividends received are classified as operating cash flows. Dividends paid to shareholders, by contrast, sit in financing. These classification rules are set by ASC 230 and can differ under IFRS, where companies have more choice.
Cash flow from investing activities
Investing activities report cash spent on or received from long-term assets: purchases of property, plant, and equipment (often labeled capital expenditures or capex), acquisitions of other businesses, and purchases or sales of investment securities. Outflows here are common for growing companies and are not inherently negative.
A large, sustained negative investing number can mean a company is expanding capacity, while a large positive number may mean it is selling off assets. Reading this section next to operating cash flow shows whether the business can fund its own growth.
Cash flow from financing activities
Financing activities report cash raised from or returned to investors and lenders: issuing stock, borrowing or repaying debt, paying dividends, and repurchasing shares. This section reveals how a company funds the gap when operations and investing do not balance, and how it returns capital to owners.
Consistent outflows in financing (debt repayment, dividends, buybacks) often indicate a mature, cash-generating business. Consistent inflows can mean a company is still dependent on outside capital to operate.
Direct method vs indirect method
The direct and indirect methods differ only in how the operating section is presented; the investing and financing sections are identical under both, and both produce the same net cash from operations. The direct method lists actual cash receipts and payments. The indirect method starts with net income and adjusts for non-cash items and working capital changes.
The indirect method is used by roughly 99% of U.S. public companies, because the inputs come straight from the income statement and balance sheet already in the accounting system. ASC 230 encourages the direct method but does not require it, and companies that use the direct method must also provide an indirect reconciliation.
| Feature | Direct method | Indirect method |
|---|---|---|
| Starting point | Gross cash receipts and payments | Net income (accrual basis) |
| How operating cash is shown | Lists cash from customers, cash to suppliers, etc. | Adjusts net income for non-cash items and working capital |
| Data effort | Higher (requires cash-basis detail) | Lower (uses existing statements) |
| U.S. adoption | ~1% of public companies | ~99% of public companies |
| Reconciliation required | Yes, must also show indirect reconciliation | No separate reconciliation needed |
| Investing and financing sections | Identical | Identical |
For the indirect method, the core adjustment rules are consistent: add back non-cash expenses such as depreciation and amortization, then adjust for changes in working capital. An increase in an asset (for example, accounts receivable) subtracts from cash; a decrease adds to cash. An increase in a liability (for example, accounts payable) adds to cash; a decrease subtracts.
A cash flow statement example
The table below shows a simple annual cash flow statement built with the indirect method for a fictional company, Meridian Supply Co., for the year ended December 31, 2025. Net income is pulled from the income statement, then adjusted to reconcile to the actual cash generated.
| Cash flow statement (indirect method), Meridian Supply Co., FY2025 | Amount ($) |
|---|---|
| Cash flow from operating activities | |
| Net income | 420,000 |
| Add: Depreciation and amortization | 95,000 |
| Add: Stock-based compensation | 30,000 |
| Increase in accounts receivable | (60,000) |
| Decrease in inventory | 25,000 |
| Increase in accounts payable | 40,000 |
| Net cash from operating activities | 550,000 |
| Cash flow from investing activities | |
| Purchase of equipment (capex) | (300,000) |
| Sale of investment securities | 50,000 |
| Net cash from investing activities | (250,000) |
| Cash flow from financing activities | |
| Proceeds from long-term debt | 100,000 |
| Repayment of debt | (75,000) |
| Dividends paid | (60,000) |
| Net cash from financing activities | (35,000) |
| Net increase in cash | 265,000 |
| Beginning cash balance | 180,000 |
| Ending cash balance | 445,000 |
Reading the example: Meridian earned $420,000 in net income but generated $550,000 in operating cash, because non-cash charges like depreciation reduced profit without using cash. It spent $250,000 net on investing, mostly on equipment, a sign of expansion. It returned $35,000 net through financing. Cash rose $265,000, and the $445,000 ending balance would match the cash line on Meridian’s December 31, 2025 balance sheet.
How to prepare a cash flow statement (indirect method)
Preparing the statement under the indirect method takes four steps, using the income statement and two consecutive balance sheets as source data. The goal is to convert accrual-basis net income into the actual change in cash, then classify the remaining cash movements into investing and financing.
- Start with net income from the bottom of the income statement.
- Add back non-cash expenses (depreciation, amortization, stock-based compensation) and adjust for changes in current operating assets and liabilities to reach net cash from operations.
- List cash from investing: capital expenditures, asset sales, acquisitions, and purchases or sales of securities.
- List cash from financing: debt issued or repaid, stock issued or repurchased, and dividends paid. Sum the three sections, add the beginning cash balance, and confirm the ending balance ties to the balance sheet.
Frequently asked questions
What are the three parts of a cash flow statement?
The three parts are operating activities, investing activities, and financing activities. Operating covers cash from the core business, such as customer receipts and supplier payments. Investing covers buying and selling long-term assets like equipment. Financing covers raising and returning capital through debt, stock, and dividends. The three subtotals combine to equal the net change in cash for the period.
What is the difference between the direct and indirect method?
The two methods differ only in the operating section. The direct method lists actual cash receipts and payments, such as cash collected from customers. The indirect method starts with net income and adjusts for non-cash items and working capital changes. Both produce the same net operating cash figure, and the investing and financing sections are identical. About 99% of U.S. public companies use the indirect method.
Why is the cash flow statement important?
The cash flow statement shows whether a business actually generates cash, which the income statement cannot, because profit is booked on an accrual basis. A company can report net income yet run short of cash if customers pay slowly or inventory ties up funds. Lenders and investors use the statement to assess liquidity, debt capacity, and whether operations can fund growth without outside money.
Is the cash flow statement required under GAAP?
Yes. FASB ASC 230 requires a statement of cash flows as part of a complete set of financial statements for most entities, for each period an income statement is presented. It is one of the three primary financial statements under U.S. GAAP, alongside the income statement and balance sheet. Requirements can differ for private companies and vary somewhat under IFRS.
How does the cash flow statement connect to the other statements?
Net income at the top of the operating section comes from the income statement. The changes in working capital and non-cash charges come from comparing two consecutive balance sheets. The ending cash balance on the cash flow statement equals the cash line on the current balance sheet. This linkage is why the three statements are read together rather than in isolation.
Where do interest and dividends go on the cash flow statement?
Under U.S. GAAP (ASC 230), interest paid, interest received, and dividends received are classified as operating cash flows. Dividends paid to shareholders are classified as financing activities. These rules are more prescriptive under U.S. GAAP than under IFRS, which allows companies more discretion in classifying interest and dividends between operating and financing.
For the other two core reports, see our guides on how to read an income statement and how to read a balance sheet. The choice between recognizing revenue and cash on an accrual or cash basis is covered in cash vs accrual accounting, and the standard behind operating-cash timing is explained in ASC 606 revenue recognition.
Reviewed by The Ledgerism Editorial Team. Last reviewed: July 2026.