How to Read a Cash Flow Statement

If we already have a Balance Sheet and a Profit & Loss (P&L) Statement, then why is the Cash Flow Statement necessary? It’s a question most beginners in finance often ask—and rightly so. 

Think of it this way: 

• The Balance Sheet gives a snapshot of the company’s financial standing on a specific date—assets, liabilities, and how much cash is lying in the bank. 

• The P&L Statement shows how much profit or loss was made over a period, based on accrual accounting. 

But neither tells you how much actual cash moved in and out of the business during that time. 

That’s where the Cash Flow Statement comes in. It breaks down the company’s cash movement from three key activities: operations, investments, and financing. This insight is crucial for understanding a company’s liquidity and sustainability. 

Real-Life Scenarios to Understand Cash Flow 

Let’s simplify the concept with two real-world situations: 

Scenario 1: The Coconut Vendor 

A coconut vendor sells 500 coconuts in a day at ₹50 each, totalling ₹25,000 in sales. Each coconut cost him ₹40, so his total expense was ₹20,000. Once he pays this amount back to his supplier, he’s left with ₹5,000—both as net profit and actual cash in hand. 

Here, his P&L and Cash Flow Statement both reflect ₹5,000 positively. 

Scenario 2: The Electronics Shop 

Now imagine an electronics shop owner sells 10 laptops for ₹25,000 each—but on credit. He earns a theoretical profit of ₹50,000 since the laptops cost him ₹20,000 each. However, because no cash was received immediately, his cash flow for the day is zero. 

These examples clearly show that profits don’t always mean positive cash flow. You need to analyze both dimensions for an accurate picture. 

Understanding the Cash Flow Statement 

Cash flow is the net movement of cash and cash-equivalents during a certain period. The cash flow statement is typically categorized into three segments: 

1. Operating Activities 

Cash generated from the core business—selling goods or services, paying salaries, rent, etc. 

2. Investing Activities 

Cash used in buying or selling assets, investing in other businesses, or purchasing equipment. 

3. Financing Activities 

Cash movements from borrowing, repaying loans, issuing equity, or paying dividends. 

For example, here’s a snippet from Godrej Industries’ cash flow (FY ending March 31, 2021): 
While they had positive cash flow from operations, their overall cash flow turned negative due to high investment outflows. 

How to Analyze a Cash Flow Statement 

Reading the numbers is just the start—interpreting trends is where the real value lies. Here's how you can dig deeper: 

•  A consistently rising cash flow from operations is a green flag. It shows the business is generating solid returns from its core activities. 

•  Be cautious if cash flow from operations is lower than net income—this may indicate earnings are being propped up by non-cash adjustments. 

•  Negative or fluctuating operating cash flows could be a red flag—unless backed by a clear strategy or transition phase (like startups scaling up or restructuring). 

•  On the flip side, negative cash flows driven by one-off events (e.g., VRS, asset write-offs) might present an opportunity, not a threat. Look at the trend, not just a single period. 

• A gradual decline in positive cash flows over time could indicate operational inefficiencies and should be investigated further. 

• Consistent investment outflows may signal growth strategies, or just surplus cash being parked. It could also imply upcoming dividends or buybacks—but always verify through subsidiary financials if investments go that route. 

Key Takeaways 

• A cash flow statement reveals the real liquidity of a company—how much cash is actually being generated and used. 

• In high-growth markets like India, profits may be reinvested, which means cash flows and profits might not always align. 

• For investors, promoters, analysts, and traders alike, the cash flow statement is a critical lens into a company’s financial health.