What a cash flow statement shows

A company can show a profit and still run out of cash: profit includes credit sales not yet collected, and is reduced by depreciation, which costs no cash. So, beside the balance sheet and the statement of profit and loss, companies prepare a cash flow statement, under AS-3. It is part of the financial statements (Section 2(40) of the Companies Act, 2013).

It shows the inflows and outflows of cash and cash equivalents during a period, grouped into three activities: operating, investing and financing.

Its benefits: it helps judge the firm's liquidity and solvency, and its ability to generate cash; it lets you compare firms without the effect of their different accounting methods; and it checks how good past estimates of cash flows were.

What counts as cash:

• Cash: cash in hand and demand deposits with banks.
• Cash equivalents: short-term, highly liquid investments that turn into a known amount of cash with very little risk, usually maturing within 3 months, such as a short treasury bill. Equity shares are usually not cash equivalents, since their value can change a lot.

Moving money between cash and cash equivalents is not a cash flow: it is still cash.