Cash Flow Statement Modeling
Translate accrual earnings into actual cash. Build Operating (CFO), Investing (CFI), and Financing (CFF) sections that reconcile Beginning Cash to Ending Cash and link cleanly to the Income Statement and Balance Sheet.
Analyst Objective
Learn to translate Net Income into a clean cash flow bridge that ties exactly to Beginning and Ending Cash, while keeping CFO/CFI/CFF clearly separated
What You'll Learn
1Structure & Cash Linkages
The Cash Flow Statement (CFS) reconciles accrual earnings to actual cash. We build three sections—CFO, CFI, CFF—and ensure they roll to ΔCash, which ties Beginning ↔ Ending Cash on the Balance Sheet.
CFO
Start at Net Income, add back non‑cash items, adjust for working capital. Measures cash from core operations.
CFI
Long‑term assets and investments: CapEx (−), asset sales (+), acquisitions (−), divestitures (+).
CFF
Debt and equity: borrowings/repayments, issuances/buybacks, dividends.
Identity: ΔCash = CFO + CFI + CFF and Ending Cash = Beginning Cash + ΔCash.
2Operating Cash Flow (CFO)
We use the indirect method: begin with Net Income, add back non‑cash items, then adjust for changes in operating working capital. CFO reveals the cash-generating power of core operations.
Core Formula
Start
Bottom line after-tax earnings
+ Add‑backs
Non-cash charges that reduced NI
± ΔNWC
Operating asset/liability changes
Complete Worked Example: Building CFO Step-by-Step
(From Income Statement bottom line)
Company generated $34M in operating cash despite $20M NI due to strong D&A add-backs, partially offset by working capital growth
CFO Best Practices
- Line Item Transparency: Use explicit rows for each add‑back (D&A, SBC, etc.); avoid lumping into a single "Other" line
- Gains/Losses: Separate gains/losses on asset sales from CFI to avoid double counting the cash proceeds
- Driver-Based NWC: Link working capital changes to DSO/DIO/DPO assumptions for scenario flexibility
- Quality Check: CFO should typically exceed Net Income for mature businesses; if not, investigate working capital trends
- Reference Structure: Keep all assumptions on a dedicated tab; use cell references, not hardcoded values
3Non‑Cash Adjustments
Add back charges that reduce Net Income but do not use cash, and remove gains that increased Net Income but did not provide operating cash. These adjustments reconcile accrual accounting to cash reality.
Core Principle
If an expense reduced Net Income but didn't use cash: Add it back
If a gain increased Net Income but didn't provide cash: Subtract it
Goal: Convert from accrual basis (what was earned/owed) to cash basis (what was actually collected/paid)
Common Add‑Backs (+)
Common Subtractions (−)
Complete Worked Example: Non-Cash Adjustments
Scenario: Company sold equipment for $8M (book value: $10M)
Advanced Edge Cases
Non-cash gains/losses from mark-to-market accounting (unless settled). Common for derivatives, trading securities, or fair value investments.
Differences between book taxes (P&L) and cash taxes paid. DTAs increase → benefit to NI but no cash. DTLs increase → charge to NI but no cash paid.
Interest accrued and added to debt principal rather than paid in cash. Reduces NI but doesn't use cash (yet).
Cash was spent upfront when debt was issued (shown in CFF), but P&L expense recognized over time via amortization.
Non-Cash Adjustment Best Practices
- Line-by-Line Clarity: Show each adjustment separately (D&A, SBC, impairments, etc.) rather than bundling into "Other"
- Gain/Loss Matching: Ensure gains/losses removed from CFO have corresponding cash proceeds/costs shown in CFI
- Sign Discipline: Non-cash expenses are positive adjustments (+); non-cash gains are negative adjustments (−)
- Cross-Statement Ties: D&A must match IS expense; SBC should tie to equity changes in BS
- Tax Timing: When modeling deferred taxes explicitly, ensure cash tax paid appears in CFO (not just book tax expense)
- Documentation: Note assumptions for complex items like fair-value adjustments or PIK interest in model assumptions tab
4Working Capital Adjustments
Reverse accrual movements to reflect the cash impact of operations. Increases in operating assets are uses of cash; increases in operating liabilities are sources of cash. This is where the Balance Sheet and Cash Flow Statement connect most directly.
Days‑Based Driver Formulas
Accounts Receivable
Example:
Revenue = $220M, DSO = 45 days
AR = ($220M × 45) / 365 = $27.1M
Increase in AR → Use of cash (negative to CFO)
Inventory
Example:
COGS = $132M, DIO = 60 days
Inv = ($132M × 60) / 365 = $21.7M
Increase in Inv → Use of cash (negative to CFO)
Accounts Payable
Example:
COGS = $132M, DPO = 40 days
AP = ($132M × 40) / 365 = $14.5M
Increase in AP → Source of cash (positive to CFO)
Complete Working Capital Impact Example
Year-over-Year Balance Sheet Changes → Cash Flow Impact:
Company extended more credit; cash not yet collected
More inventory purchased than sold; cash tied up
Delayed payments to suppliers; preserved cash
Company growing faster than collecting → cash outflow despite profitability
Working Capital Best Practices
- Sign Convention: Increases in assets (AR, Inventory) are negative to CFO; increases in liabilities (AP, Accruals) are positive to CFO
- Operating vs Financing: Exclude current portion of long-term debt and dividends payable from operating NWC
- Driver Consistency: Use average historical DSO/DIO/DPO to anchor forecasts; adjust only for known policy changes
- Growth Impact: Fast-growing companies typically experience NWC drag as AR/Inventory outpace AP
- Cash Conversion Cycle: DSO + DIO − DPO = CCC; lower is better for cash generation
5Investing Cash Flow (CFI)
Capture long‑term investment decisions. Most commonly negative (spending on PP&E or acquisitions), positive when disposing assets or investments.
Typical Lines
- − Capital Expenditures (PP&E)
- + Proceeds from Sale of PP&E
- − Acquisitions / + Divestitures
- − Purchases of Investments / + Sales of Investments
Roll‑Forward Touchpoints
- CapEx ↔ PP&E roll‑forward (BS)
- Acquisitions ↔ Intangibles/Goodwill (BS)
- Gains/Losses ↔ CFO adjustments (remove from NI, show cash in CFI)
Avoid double counting: if a gain increased Net Income, subtract it in CFO and show the cash proceeds in CFI.
6Financing Cash Flow (CFF)
Show how capital structure changes affect cash: debt drawdowns/repayments, equity issuance/buybacks, and dividends.
Debt
- + Borrowings
- − Repayments
- ± Debt issuance costs (cash)
Equity
- + Equity Issuance (Primary)
- − Share Buybacks
- ± Transaction costs (cash)
Distributions
- − Dividends Paid
- − Non‑controlling interest distributions
Linkages: Dividends tie to Retained Earnings; net debt changes tie to the debt roll‑forward; share count impacts EPS on the IS.
7Net Change in Cash & Reconciliation
Summarize the three sections to arrive at ΔCash, then roll Beginning to Ending Cash. This line must exactly match the Cash change on the Balance Sheet.
Ending Cash = Beginning Cash + ΔCash
Circularity note: Interest income/expense can create circular references if modeled from average cash/debt. Use fixed assumptions or a one‑iteration approach until Lesson 5.
8Integrations with IS & BS
Income Statement ↔ CFS
- Net Income is the starting point for CFO (indirect method).
- D&A appears as an expense on the IS and an add‑back in CFO.
- Gains/losses on asset sales removed from CFO; cash proceeds shown in CFI.
Balance Sheet ↔ CFS
- ΔWorking Capital lines come from BS movements (AR, Inv, AP, etc.).
- CapEx changes PP&E; acquisitions change Intangibles/Goodwill.
- ΔDebt and equity transactions reconcile CFF and BS financing lines.
- Ending Cash on CFS equals Cash on BS.
Interactive Cash Flow Demo
Watch how the Cash Flow Statement is built step-by-step, starting from Net Income and working through CFO, CFI, and CFF to arrive at Ending Cash.
Step 1: Net Income
Start with Net Income from Income Statement
Pro Tip: Trace mismatches by walking CFO add‑backs and each ΔNWC line before inspecting CFI/CFF. Most errors arise from sign conventions or gain/loss double counting.
9Cash Bridge Example Table
| Line | 2023A | 2024E | 2025E | Formula / Notes |
|---|---|---|---|---|
| Net Income | 18 | 20 | 24 | IS → starting point |
| + Depreciation & Amortization | 9 | 11 | 12 | Add‑back (non‑cash) |
| + SBC | 2 | 3 | 3 | Non‑cash compensation |
| ± Gains/Losses | 0 | −1 | 0 | Remove gains (−), add losses (+) |
| − ΔAR | −1 | −2 | −3 | Use of cash |
| − ΔInventory | −2 | −2 | −1 | Use of cash |
| + ΔAP | +1 | +2 | +2 | Source of cash |
| CFO | 27 | 31 | 37 | = NI + add‑backs + ΔNWC |
| − CapEx | −12 | −14 | −16 | % of revenue or schedule |
| + Proceeds from Asset Sales | 1 | 0 | 2 | Cash only; gain removed in CFO |
| CFI | −11 | −14 | −14 | Investing activities total |
| + Net Borrowings | 4 | 2 | 0 | Debt drawdowns − repayments |
| − Dividends Paid | −3 | −4 | −5 | Links to RE roll‑forward |
| − Share Buybacks | −1 | 0 | −2 | Impacts share count/EPS |
| CFF | 0 | −2 | −7 | Financing activities total |
| ΔCash | 16 | 15 | 16 | = CFO + CFI + CFF |
| Beginning Cash | 20 | 36 | 51 | Prior year ending |
| Ending Cash | 36 | 51 | 67 | = Beg + ΔCash → tie to BS |
Insight: Strong CFO with sustained CapEx suggests reinvestment; negative CFF indicates cash returned to capital providers.
10Practical Modeling Techniques
Split Sections Clearly
Structure CFO/CFI/CFF in distinct blocks; subtotal each before the ΔCash roll‑up.
Guardrails & Checks
Add assertions: (Beg + ΔCash = End), (CFO + CFI + CFF = ΔCash), and End Cash ≥ Min Cash.
Avoid Early Circularity
Treat interest/dividends as inputs until you implement iterative calc logic.
Scenario‑Friendly Drivers
Keep CapEx%, DSO/DIO/DPO, dividend payout% on an Inputs tab; drive CFS via references.
Auditability
Use roll‑forward blocks (PP&E, Intangibles, Debt) and label each cash touchpoint.
Key Takeaways
CFO bridges Net Income to cash — prioritize clarity of add‑backs and ΔNWC.
Show cash proceeds in CFI; remove the accounting gain/loss in CFO.
CFF reveals capital allocation strategy (raise vs return).
ΔCash identity must hold, and Ending Cash must tie to the Balance Sheet.
Keep drivers centralized; prefer references over hardcodes for scenario control.