Home » Accounting Explanation » Cash flow statement

For any business entity it is important to ensure that:

  • Sufficient profits or earnings are being made to compensate owner of the business and to finance the business activities
  • There is sufficient availability of cash to a business so that the business can use it at the time of its needs. For example a business needs funds for paying off its creditors and expenses

The information regarding the profitability of a business is provided by the income statement or profit and loss account

The information concerning the financial health or financial position of a business can be obtained by observing the Balance sheet

The information related to cash or funds availability and movements of cash is acquired by preparing a Cash flow statement of that business

Cash flow statement

It is one of the most important financial statements which provides the information about the movement of cash into and out of business during a certain accounting period. In other words cash flow statement is a simple financial statement that let you know how a business has generated cash and how it has spent the cash during an accounting period. An accounting period can be a month, half year, year or whatever time period.


Cash includes the cash available to a business or cash in hand plus the business’s cash available at bank in the form of demand deposit

Cash = Cash in hand + Cash at bank

Cash Equivalents

Cash equivalents are current assets which can be converted into cash within 3 months such as short term debtors, notes receivable, and short term investments with maturity up to three months


Liquidity of an asset can be defined as the ease with which an asset can be converted into a mean of payment i.e. money or cash

An Asset is said to be liquid if it can be converted into cash or money easily at any time

A business has more liquidity if it has more cash and liquid assets such as short term investments, short term debtors, demand deposits etc.


Profitability is the amount of earnings or profits a business has made by selling its goods or services

More profitability implies that more profits are being made from business activities

Is liquidity same as profitability of a business entity?

No, not at all. Liquidity is not same as profitability of a business. Liquidity concerns with the availability of cash and cash equivalents while profitability is related to the amount profits or earnings  made by a business


 A Person started a business with cash $1000
 He purchased Goods for that $1000
 He sells these Goods for $2000 on credit
 After three months he draws income statement of his business
 According to income statement, his business made a profit of $1000 ($2000-$1000=$1000 of profit, Assuming no other expense). Though, his business has made $1000 profit but his business has no cash available

Conclusion, Profitability=$1000 and Liquidity=0

Cash flow statement shows where cash comes from and where it goes during a period

To better understand this we have to list down some of the business’s activities that bring cash into business and that take the cash out of the business

These activities bring cash into the business
  1. Sales of Fixed assets
  2. Decrease in stock or inventory level
  3. Decrease in Debtor
  4. Fresh capital introduction
  5. All kind of profits
  6. Loan received
  7. Increase In creditors

These activities take cash out of business
  1. Purchase of Fixed assets
  2. Increase in stock or inventory level
  3. Increase in Debtor
  4. Drawings or withdrawals of capital
  5. All kind of losses
  6. Loan repaid
  7. Decrease in creditors

Explanation of these activities

1. Business receives cash for the sales of fixed assets and business pays cash for the purchase of these assets

2. Decrease in stock brings cash into the business because reduction in stock implies that business has sold some of its stock which in turn brings cash into business and increase in stock means business has purchased stock or goods which takes out business cash

3. Decrease in debtor brings cash into business because some debtors has repaid business cash and Letting the debtors grow implies that limiting cash inflows

4. Fresh capital will definitely brings cash into business because the owner or owners are introducing cash into the business in the form of capital and drawings implies that cash is being taken out of business by the owner or owners

5. Profit brings cash and losses make the cash goes out of business

6. Since loans are received in the form of cash, they will bring cash into business and if business repays these loans, the business funds or cash will reduce

7. Increase in creditors means business has obtained cash from creditors which is an inflow of  cash and decrease in creditors implies that business has repaid the creditors which takes the cash out of the business