A statement of cash flows reports the change in a company’s cash position over a period and explains why it happened. The income statement reports revenues and expenses on an accrual basis (recognise revenue when earned, expenses when incurred, not when cash actually moves). The statement of cash flows traces the actual movement of cash.
Three categories of activities:
Operating activities. Cash generated or used by day-to-day operations: cash collected from customers, cash paid to suppliers and employees, interest paid and received, income taxes paid. The most important section, since it measures whether the business itself produces cash.
Investing activities. Cash used to buy long-term assets (PP&E, equipment, businesses) and cash received from selling them. Negative numbers here are normal for growing companies investing in their future.
Financing activities. Cash raised by issuing debt or stock, cash used to repay debt, dividends paid. Tells you whether the company is borrowing/issuing stock (positive) or paying back/buying back (negative).
Sum the three sections to get the net change in cash for the period. Add the beginning-of-period cash balance and you get the end-of-period balance, which agrees with the balance sheet’s cash line at that date.
Example: a profitable company sells a service on credit, collects payment 90 days later, and pays suppliers within 30 days. The income statement shows profit, but the cash-flow statement shows negative operating cash flow during the gap. Profitable but cash-strapped is one of the most common reasons growing companies fail. The income statement says “doing well”; the cash-flow statement reveals the squeeze.
The relationship: operating cash flow + investing cash flow + financing cash flow = change in cash. Operating cash flow itself relates to net income via working-capital changes, depreciation add-backs, and other reconciliations.
See also Income statement, Balance sheet, and Financial ratio analysis.