Why Cash Flow Matters
The Income Statement shows profit, but profit is an accounting concept. Cash is reality. A business can show ₱100,000 in net income and still not have enough cash to make payroll. The Cash Flow Statement bridges that gap — it shows every actual peso that entered or left the business's bank accounts.
Why Cash Flow Differs From Profit
Several things cause cash and profit to diverge:
- Credit sales: You record revenue when you send the invoice (accrual), but cash doesn't arrive until the customer pays — which could be 30 or 60 days later.
- Equipment purchases: Buying a ₱50,000 oven is a cash outflow immediately, but the expense (depreciation) is spread over years on the Income Statement.
- Loan payments: The principal portion of a loan payment reduces cash but isn't an expense — only the interest portion appears on the Income Statement.
- Owner's draws: Taking money out of the business reduces cash but isn't an expense — it reduces equity.
- Inventory purchases: Buying inventory reduces cash immediately, but the cost isn't recognized (as COGS) until the inventory is actually sold.
Profit is an opinion. Cash is a fact.
This old accounting saying captures why the Cash Flow Statement matters. A business can survive without profit for a while. It cannot survive without cash.
The Three Sections
The Cash Flow Statement is organized into three sections, each showing a different source and use of cash:
| Section | What It Covers | Examples |
|---|---|---|
| Operating Activities | Cash from day-to-day business operations | Cash received from customers, cash paid to suppliers, cash paid for wages, rent, utilities |
| Investing Activities | Cash from buying or selling long-term assets | Purchasing equipment, selling a vehicle, buying property |
| Financing Activities | Cash from borrowing, repaying loans, or owner transactions | Taking out a loan, repaying loan principal, owner's capital contributions, owner's draws |
What Goes in Each Section
Operating Activities: This is the most important section. It converts net income (accrual) to actual cash. Start with net income, then adjust for non-cash items (depreciation is added back because it reduced income but didn't use cash) and changes in working capital (if accounts receivable went up, customers owe you more but haven't paid — that's a cash decrease).
Investing Activities: Any purchase or sale of fixed assets. If the bakery bought a new oven for ₱35,000, that's a ₱35,000 outflow in this section. If they sold an old mixer for ₱5,000, that's an inflow.
Financing Activities: Borrowing money is a cash inflow. Repaying the principal of a loan is a cash outflow. Owner contributions are inflows, and owner's draws are outflows. Interest payments are not here — they're in operating activities because interest is an expense.
Key insight
A healthy business generates positive cash from operating activities. If operating cash flow is negative, the business is burning cash from its core operations and must be funding itself through loans or owner contributions. That's not sustainable.
How to Read a Cash Flow Statement
When reviewing a Cash Flow Statement, check these things:
- Is operating cash flow positive? If yes, the core business generates cash. If no, the business is bleeding money from operations.
- What's happening in investing? Heavy investing (buying equipment) isn't necessarily bad — it means the business is growing. But if operating cash flow can't cover it, the business needs outside funding.
- What's happening in financing? Are they taking on more debt? Repaying it? Is the owner putting money in or taking it out?
- Net change in cash: Add up all three sections. If the result is positive, the business's cash balance grew. If negative, cash shrank.
Burning cash despite being profitable
This happens when a business is growing fast — it buys inventory before it sells it, and it extends credit to customers who haven't paid yet. The Income Statement looks great (revenue is up!), but the bank account is empty. This is called a growth cash trap, and it's one of the most common reasons small businesses fail.
Sample Cash Flow Statement — Sweet Crumbs Bakery
For the year ended December 31, 2025. All figures in Philippine Pesos (₱).
| Line Item | Amount (₱) |
|---|---|
| OPERATING ACTIVITIES | |
| Net Income (from Income Statement) | 161,500 |
| Add: Depreciation Expense (non-cash) | 15,000 |
| Less: Increase in Accounts Receivable | (5,000) |
| Less: Increase in Inventory | (8,000) |
| Add: Increase in Accounts Payable | 6,000 |
| Add: Increase in Sales Tax Payable | 2,000 |
| Net Cash from Operating Activities | 171,500 |
| INVESTING ACTIVITIES | |
| Purchase of Equipment | (35,000) |
| Net Cash from Investing Activities | (35,000) |
| FINANCING ACTIVITIES | |
| Owner's Capital Contribution | 20,000 |
| Loan Proceeds Received | 15,000 |
| Loan Principal Repaid | (10,000) |
| Owner's Draws | (10,000) |
| Net Cash from Financing Activities | 15,000 |
| NET CHANGE IN CASH | 151,500 |
| Cash at Beginning of Year | 28,500 |
| Cash at End of Year | 180,000 |
Check the math
Operating ₱171,500 + Investing (₱35,000) + Financing ₱15,000 = ₱151,500 net change in cash. Beginning cash ₱28,500 + ₱151,500 = ₱180,000 ending cash. This should match the Cash accounts on the Balance Sheet (₱85,000 checking + ₱40,000 savings = ₱125,000... plus the beginning-of-year cash was ₱28,500, with ₱151,500 added during the year). The business generated strong operating cash flow and invested in equipment while keeping cash healthy.