The cash flow statement

Northwind earned $2,550 and its operations consumed $3,100. The third statement is the one that explains the difference, line by line.

Reading: 12 min
Teaches: 7
Sources: 5

Two statements in, and one question is still unanswered: the bank has $32,900 and the profit was $2,550, so where did the rest come from and where did it go? The cash flow statement answers it by starting at net income and undoing every place accrual accounting and cash disagree.

Northwind Traders, Inc. — statement of cash flows

For the month ended 30 September 2026 · USD · indirect method

Operating activities
Net income	2,550.00
Depreciation	500.00
Increase in accounts receivable	(8,000.00)
Increase in inventory	(1,000.00)
Increase in prepaid insurance	(6,600.00)
Increase in accounts payable	6,000.00
Increase in accrued liabilities	450.00
Increase in deferred revenue	3,000.00
Net cash from operating	(3,100.00)
Investing activities
Purchase of vehicle	(24,000.00)
Net cash from investing	(24,000.00)
Financing activities
Issue of common stock	60,000.00
Net cash from financing	60,000.00
Net change in cash	32,900.00
Cash at 1 September	0.00
Cash at 30 September 2026	32,900.00

It ends on the bank balance. A cash flow statement that does not is not finished.

Northwind Traders, Inc. — for the month ended 30 September 2026. Indirect method.

Fig 12.1Cash-flow waterfall

Drag to turn · click to replayClosing cash $32,900.00

Opening cash of zero, through operating ($3,100 out), investing ($24,000 out) and financing ($60,000 in), into the cash in the bank on 30 September.

Reading the operating section

Three kinds of line show up between net income and operating cash. Non-cash expenses are added back — depreciation cost $500 of profit and moved no money. Increases in operating assets are subtracted — every dollar of receivable is revenue that has not arrived, every dollar of inventory or prepaid insurance is cash spent ahead of the expense. Increases in operating liabilities are added — the supplier, the unbilled utility and the customer's deposit are all, in effect, funding Northwind for free.

The other two sections are simpler. Investing is buying and selling long-lived assets and investments — the $24,000 van, a capital expenditure. Financing is cash from, or returned to, the owners and lenders who fund the business — the founders' $60,000. Sum the three and you must land exactly on the change in the bank balance, which in a first month is the balance itself.

The working-capital lines are not a stylistic choice either — the standard names the minimum set, and receivables, inventory and payables are all on it.

The same number, the direct way

There is a second way to present the operating section, and the standard encourages it: the direct method lists the operating cash that actually came in and went out. Almost nobody uses it, because the indirect walk falls straight out of the ledger. But it is the best proof that the indirect walk is not a trick — take every movement through the bank account except the van and the founders' money, and you land on the same (3,100).

Entry	What happened	Cash
JE-3	Twelve months of insurance is paid up front: $7,200.	(7,200)
JE-5	A walk-in customer buys $9,500 of goods and pays on the spot.	9,500
JE-9	Northwind pays $12,000 against the supplier's bill.	(12,000)
JE-10	The trade customer pays $14,000 of the September invoice.	14,000
JE-11	September payroll of $8,400 is paid. (Kept simple: no withholding or payroll taxes.)	(8,400)
JE-12	A customer pays a $3,000 deposit for goods to be delivered in October.	3,000
JE-13	September rent of $2,000 is paid.	(2,000)
	Net cash from operating activities	(3,100)

Operating cash, direct method — every movement through 1000 Cash that was not investing or financing.

Your turn

Walk $2,550 of profit to $32,900 in the bank

Start at net income, add back what cost no cash, and take out what moved cash without touching profit. The walk is right when the total equals the change in the bank balance — and in a first month, the change is the balance.

Walk $2,550 of profit to $32,900 in the bank
Row	ALine	BSection	CAmountNegative in parentheses
1
2
3
4
5
6
7
8
9
10
11
12
13

Operating2,550.00

Investing(24,000.00)

Financing60,000.00

Net change in cash38,550.00

Your walk is 38,550.00; the book says 32,900.00. You are out by 5,650.00.

Operating cash is positive. Check every working-capital line before you believe it — a missing receivable movement flatters this number.

What a founder reads off it

Operating cash less capital expenditure is free cash flow: (27,100) in September, almost all of it the van. It is not a GAAP measure — no standard defines it, and a public company that reports it has to reconcile it to one that is. Runway is the same kind of number: if operations kept consuming $3,100 a month, $32,900 would last about ten months. Both are only as honest as the cash flow statement they are read from.

Profit is an opinion about a period; cash is a fact about a bank account. A business fails when it runs out of the second, whatever the first says.

Check yourself

October: Northwind collects the remaining $8,000 receivable but makes no new sales, while rent, payroll and the rest carry on. What does the collection do?

Where this lesson's rules come from

Requirements, conventions and mechanics are three different things. These are the sources behind the requirements — and the ones marked as conventions are ours, not the standard-setters'.

ASC 230-10-45-10Cash flows are classified as operating, investing or financingFree after registration
ASC 230-10-45-28, -45-29The indirect method, and what it must separately reportFree after registration
ASC 230-10-45-24The statement must reconcile beginning and ending cashFree after registration
ASC 230-10-45-25; 230-10-50-2The direct method is encouraged; an entity using the indirect method must disclose interest and income taxes paidFree after registration
SEC Release 33-8176 — Regulation G, 17 CFR 244.100(a)(2); Item 10(e) of Regulation S-KNon-GAAP financial measures must be reconciled to the GAAP measureFree to read

The full map is in US GAAP, and where these rules come from.

The words this lesson teaches

Each links to its definition in the glossary, where it also states the authority behind it and the components that render it.

In the founder glossary

The ideas in this lesson, explained for the founder who runs the company. Each has its own entry in the founder glossary.