Do you have money tied up in stock—perhaps in the company you work for, or shares you bought because you like the company’s products or business model? If so, you’ve hopefully been learning how to read financial statements. You know that the balance sheet shows a company’s assets and liabilities as of a specific date, and that the income statement shows a company’s income and expenses over a period of time. The missing piece to understanding a company’s entire financial picture is the statement of cash flows.

　　The statement of cash flows (or cash flow statement) shows the actual money that comes into and goes out of the business on its income statement over a period of time and then ends up as cash on its balance sheet.

　　Components of the cash flow statementA statement of cash flows breaks business activities into three sections: operating, investing, and financing.

　　Investing and financing activities are always calculated the same way for any cash flow statement. However, operating activities can be calculated via either the direct or indirect method:

　　The direct method is uncommon. It lists cash from sales and deducts cash paid toward expenses—almost like a cash basis income statement. The indirect method takes accrual-basis profit from the income statement and makes adjustments for balance sheet line items that didn’t affect the cash received or spent during the period.Operating activities via the indirect methodOperating activities reflect how a company makes its money and what it needs to spend in order to continue doing business.

　　Net income is the starting point, although some companies use earnings before interest and taxes (EBIT).

　　Depreciation and amortization is not a cash expense—no actual cash is paid out as assets lose value—so depreciation and amortization expenses are added back to net income.

　　Change in working capital reflects how the cash in a business is affected when a company’s current assets and current liabilities change over a period of time:

　　Accounts receivable (A/R). If a company sells goods or services on credit, it doesn’t actually receive cash for those sales. An increase in A/R needs to be deducted on the statement of cash flows because the money was not yet received, and a decrease in A/R needs to be added back. Inventory. A company uses cash to purchase inventory. If inventory on the balance sheet increased during the year, that increase needs to be deducted on the statement of cash flows as money spent, and a decrease in inventory needs to be added back.Accounts payable (A/P). If a company has not paid for its electric bill or rent or other payable, cash has not been spent even if an expense is shown on the income statement. An increase in A/P needs to be added to the statement of cash flows, because the cash was not yet spent, and a decrease in A/P needs to be deducted.Interest and taxes must be deducted in the operating activities section if a company uses earnings before interest and taxes (EBIT) as the starting point in its cash flow statement.

　　Investing activitiesA company’s investing activities relate to the buying and selling of equipment as well as property such as land or buildings:

　　A purchase of these non-current assets is shown as a deduction from cash flow (because it is money spent).The sale of a non-current asset is shown as an addition to cash flow (because it is money received).Financing activitiesA company’s financing activities relate to borrowing and paying back money, paying dividends, and issuing and buying back shares of stock:

　　Debt. When a company takes out a loan or issues debt securities (i.e., corporate bonds), it receives money, which is shown as an addition to cash flow. When a company pays back that loan, it spends money, which is shown as a deduction to cash flow.Equity. When a company issues stock, it receives money, which is shown as an addition to cash flow. When a company buys back shares or pays dividends, it spends money, which is shown as a deduction to cash flow.Beginning and ending cash balanceAfter calculating the net cash increase or decrease over the period, the cash flow statement combines this change with the beginning cash balance from last period’s balance sheet to equal the ending cash balance on this period’s balance sheet:

　　Example of a cash flow statement (indirect method)Now that we’ve seen what goes into a cash flow statement, here’s what it looks like as a table. Major companies may have more line items—and may be full of footnotes and references to other tables and calculations—but the cash flow statement overall will take this shape:

　　Free cash flow (FCF) = operating cash flow – cash flow from investing activities. FCF shows how much money is left over after buying property and equipment.Cash flow coverage ratio (CFCR) = (operating cash flow/total debt)*100. CFCR shows a company’s ability to pay its debt. Divide 1 by the CFCR to calculate how long it will take the company to pay off all of its debt if it stays on its current financial course. Operating cash flow margin = (operating cash flow/net sales)*100. Operating CF margin shows the business’s profitability. Price-to-cash-flow ratio (P/CF) = share price/operating cash flow/outstanding shares. Compare P/CF to other companies in the industry to decide if you think the stock is over- or undervalued.The bottom lineA company’s statement of cash flows tracks its cash activities over a period of time. You can learn a lot about a business’s health by looking at its cash flow statement and calculating some ratios. Comparing several years of a company’s cash flow statement may highlight trends, for better or worse. Note that most online brokers—and several financial data platforms freely available online—publish the top ratios for you, making them easy to review.

　　Publicly held companies are required to file quarterly reports with the Securities and Exchange Commission. You can access these reports through a company’s investor relations section on its website, or via the SEC EDGAR database. You can also listen to the company’s quarterly earnings calls to hear company executives’ views of current business conditions.

　　Following company financials is important, not only before you invest, but also on an ongoing basis. If something changes and an investment no longer fits your objectives and risk tolerance, it might be time to move on.