How to Build a Cash Flow Statement From the Income Statement and Balance Sheet
The income statement measures accrual profit. The cash flow statement measures actual cash. Here is how to build one section by section, using the indirect method every real model relies on.
How do you build a cash flow statement?
A cash flow statement reconciles accrual net income to the actual cash a business generated over a period. Using the indirect method, start from net income, add back non-cash expenses such as D&A, subtract the increase in net working capital to get operating cash flow, then add investing and financing cash flows to reach the net change in cash.
Key takeaways
- CFO = net income + non-cash expenses − increase in net working capital.
- The three sections are operating (the core business), investing (long-term assets), and financing (capital providers).
- All three sections plus the opening cash balance give the ending cash on the balance sheet.
- An increase in an operating asset uses cash; an increase in an operating liability frees cash.
- The indirect method is what virtually every real financial statement and model uses, and what interviewers expect.
What does the cash flow statement measure?
- Cash flow statement
- The financial statement that reconciles accrual-basis net income to the actual movement of cash over a period, split into operating, investing, and financing activities.
The income statement measures profit under accrual accounting, which recognizes revenue when it's earned and expenses when they're incurred, not necessarily when cash actually changes hands. The cash flow statement exists to answer a different question: how much actual cash did the business generate or consume this period. A company can be profitable on its income statement and still run out of cash, which is exactly why this statement gets its own place among the three (see the three statements guide for how all three connect).
Interviewers ask candidates to build one, or to walk through how a specific change affects it, because doing so correctly requires knowing which income-statement and balance-sheet items are real cash movements and which aren't, the same discipline tested throughout finance interviews.
What are the three sections of the cash flow statement?
- Operating activities (CFO). Cash generated or used by the core business: collecting from customers, paying suppliers and employees, paying taxes.
- Investing activities (CFI). Cash used to acquire, or received from selling, long-term assets: capital expenditures, acquisitions, purchases or sales of securities.
- Financing activities (CFF). Cash flows between the company and its capital providers: issuing or repaying debt, issuing or repurchasing stock, paying dividends.
Summing all three sections, plus the prior period's cash balance, gives the period's ending cash balance, the same figure that appears on the balance sheet.
| Section | What it captures | Typical line items |
|---|---|---|
| Operating (CFO) | Cash from running the core business | Net income, D&A addback, working capital changes |
| Investing (CFI) | Cash spent on or received from long-term assets | Capital expenditures, acquisitions, asset sales |
| Financing (CFF) | Cash exchanged with capital providers | Debt issued or repaid, stock issued or bought back, dividends |
How do you calculate operating cash flow with the indirect method?
Almost every model builds CFO with the indirect method: start from net income, then adjust for everything that separates accrual profit from actual cash.
Non-cash expenses like depreciation, amortization, and stock-based compensation reduced net income without using any cash, so they're added back. An increase in an operating asset like accounts receivable or inventory ties up cash (revenue or product left the building before the cash came in), so it's subtracted; an increase in an operating liability like accounts payable frees up cash (the company hasn't paid yet), so it's added. The full mechanics of that piece, and how to measure how long cash stays tied up, are covered separately below.
What goes into investing and financing cash flow?
CFI is usually dominated by capital expenditures, a use of cash recorded as a negative line, plus any acquisitions (also a use of cash) or asset/security sales (a source). CFF captures every transaction with capital providers: proceeds from new debt or new equity issued are sources of cash; debt repayment, share buybacks, and dividends paid are uses.
Worked example: what does a simple cash flow statement look like?
Net income of $80, depreciation of $15, accounts receivable increases by $10, accounts payable increases by $5. Capital expenditures of $20. The company repays $10 of debt and pays a $5 dividend.
CFI = −$20
CFF = −$10 − $5 = −$15
Net Change in Cash = $90 − $20 − $15 = $55
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Common cash flow statement interview questions
What's the difference between the indirect and direct method?
The indirect method starts from net income and adjusts for non-cash items and working capital changes to arrive at operating cash flow. The direct method instead lists actual cash receipts and payments (cash collected from customers, cash paid to suppliers) directly. The indirect method is what's used in the overwhelming majority of real financial statements and financial models, and what interviewers expect by default.
Why is an increase in accounts receivable a use of cash?
An increase in accounts receivable means the company recognized revenue and booked it in net income, but hasn't actually collected the cash from customers yet. Since net income already reflects that revenue, the increase in receivables has to be subtracted to reflect that the cash hasn't arrived.
Why is depreciation added back if it already reduced net income?
Depreciation is a non-cash expense: it lowers accounting profit to reflect an asset wearing out, but no cash actually leaves the business when it's recorded. Starting from net income and adding depreciation back removes an expense that never cost any cash in the first place.
What determines whether an item goes in investing or financing activities?
Investing activities involve long-term assets the business itself owns and operates, like property, equipment, or acquired companies. Financing activities involve the company's relationship with the people who supply its capital: lenders and shareholders. A purchase of equipment is investing; a new loan to pay for that equipment is financing.
How does the cash flow statement connect to the balance sheet?
The cash flow statement's net change in cash, added to the prior period's cash balance, produces the new cash balance that appears on the balance sheet. It's one of the three links that tie the statements together; see the three statements guide for the other two.