Even though the statement of cash flows is among the most beneficial financial statements a company can use, many prepare only the conventional balance sheet and income statement. Information about a company’s gross receipts and gross payments for a given time period is provided by the statement of cash flows. This document tracks the cash and cash equivalents that are accumulated from ongoing operations and outside investments as well as those that are used for business expenses, whether it is updated annually, quarterly, or monthly.
Unpaid invoices or recently acquired contracts that have not yet been billed are not included in a cash flow statement’s analysis of a company’s net income or anticipated earnings. Instead, this report offers information on how the company is using its cash resources. Answers to crucial queries like “Where did the money go?” and “My company is profitable, so why isn’t there any cash?” can be found in the statement of cash flows.
Investors can benefit from this financial statement as well because it shows how well a company is managing its cash and growing. The likelihood that a company will increase or reduce its debt increases if more money is coming in than it is going out, increasing the value of its stock. Law also mandates that publicly traded companies give investors a statement of cash flows.
All cash inflows and outflows are considered to be either operating, investing, or financing activities. Operating activities will directly depict how the business conducts regular business, including how much money was made and how it was spent. Operating activities would include money received from customers and payments made to suppliers. The ability of the business to collect on its accounts receivable can also be determined by looking at this section of the cash flow statement. If the cash flow statement reveals a significant drop in the amount of money coming in, the company may need to alter its collection policy.
The investing-activities section of the statement illustrates how a company is getting ready for future expansion. Long-term assets like land, buildings, or equipment would be regarded as investments if they were bought or sold. Also noted here are loans made to others, insurance payouts, and sales or purchases of stocks, bonds, or securities. This section of the report assists a business in projecting its future costs or revenues, but it can also act as a warning if excessive investing diverts funds from essential operating costs.
To show changes in the company’s liability, equity, or other matters that reflect the company’s strategy for financial management, financing activities are also recorded. Financial activities would be used to record the proceeds from the sale of the company’s own stocks or bonds as well as payments made to settle debt or loans. This section of the document should reflect any changes to the company’s capital or debt.
The significance of the cash flow statement The statement of cash flows can reveal the company’s underlying growth strategies in addition to giving clear insight into how the business is using its funds. The statement may serve as a warning that a business is relying too heavily on bank financing, making too many loans to other people, or making excessive investments. Frequently, this document will be able to shed light on these elements before they are apparent in the company’s net income. Alternately, by highlighting the company’s sound management and financial standing, the statement of cash flows can be used to entice new investors.
The cash flow statement is an important tool for businesses of all sizes because it enables them to make more informed decisions about their day-to-day operations. Contact LaPortes accounting services experts for additional advice on how to create and use this crucial financial statement if you’d like more details on how to prepare a statement of cash flows.
An example of how cash flow is calculated
A cash flow statement can be extremely useful in examining a company’s financial position. It is crucial for both internal and external stakeholders, including lenders and investors, who can use it to determine whether a business is successful and deserving of investment. Here is a simple illustration of how cash flow is determined:
Barry will have a total of $25,000 to invest in his venture if he starts his small business with $10,000 in savings and an additional $15,000 loan from a private lender. During his first year, he invests the entire sum in starting his business. But after a short while, Barry’s company starts to become very profitable, and in the first year, he earns $55,000 from operating activities like sales.
Even so, some of this income came from credit transactions totaling $5,000. Barry must take into account his operating activities, investing activities, and financing activities to ascertain his cash flow position, or how much cash he currently has. Barry started his business with $10,000 of his own money and owes a private lender $15,000; therefore, to accurately calculate his cash inflow, he must deduct the sum of $25,000 from his total revenue.
With this, it is clear that Barry’s first year of business saw him only make a total profit of $30,000. Barry only has $25,000 in cash on hand, though, as he earned $5,000 through credit transactions that haven’t yet been paid. This cash flow is positive, which is good for Barry. Barry and his team can use this calculation, which accounts for all cash-related activity, to make wise business decisions in the future.
What is a cash flow statement?
A financial statement that shows how businesses use their cash is called a cash flow statement. The statement keeps track of the amount of money that flows in and out as a result of business handling and provides detailed information about a business’s cash inflow and outflow. A fundamental requirement for businesses to maintain their viability and prevent bankruptcy is having cash on hand.
This money flow is divided into three distinct categories of cash-related activity in cash flow statements:
Operating activities
The cash flow statement’s operating costs and profit items, such as accounts receivable and payable, inventory, wages due, and income taxes due, are described in this section. The operating activities section of a business’s website focuses on its primary operations, such as the sale or purchase of goods and services.
Investing activities
This section contains details about the company’s acquisition or disposal of long-term investments, such as real estate, buildings, cars, furniture, or equipment. Additional information about a company’s assets is provided in the section on investing activities.
Financing activities
All cash transactions, including notes payable, retained earnings, and dividend payments, from long-term liability and stockholder equity accounts are described in this section. The company’s net cash flow, accounting for stock purchases and debt financing, is shown in the financing activities section.
8 reasons why a cash flow statement is important
Businesses can use cash flow statements to navigate the need for productive cash-related activity. Here are eight justifications as to why your business might find a cash flow statement helpful:
Insight into spending activities
A profit and loss statement typically does not include all of the payments that a company makes, but cash flow statements do. A profit and loss statement wouldn’t include the payments made by your company to repay a loan, for example. Comparatively, a cash flow statement would incorporate this information and give information on the actual cash your company spent. A cash flow report can give you a clear picture of where your company’s money is leaving the company if you want to know where it is going.
Short-term planning
Companies can use cash flow statements to help with short-term planning in particular. For all businesses to avoid bankruptcy and fulfill obligations like paying employees, operating costs, and more Financial managers can forecast the cash flow in the near future and keep track of spending to achieve specific, short-term goals by using cash flow statements, which give a detailed report on how much cash a business has on hand at any given time.
Better picture of cash planning results
Typically, businesses develop cash flow plans to follow in order to make sure their ventures are successful. Even so, there are times when businesses are unable to perfectly execute their cash plans or achieve the goals set during the planning period. By allowing readers to compare projected cash flow figures to actual cash flow results, a cash flow statement can help businesses determine whether their cash planning was actually effective. Businesses can use this data to forecast the future with greater accuracy.
Ability to increase cash inflow
Businesses can concentrate on raising money through activities other than making profits when they have information about their current inflow and outflow. Cash can be generated in other ways besides through profit, and these methods may occasionally be more profitable overall. For example, if staff members discover that the company is spending a lot of money on inventory, they can try to generate extra cash by streamlining processes, such as using inventory effectively to speed up receivables collection.
Improved knowledge of cash balance
Business owners and other stakeholders must understand the ideal cash flow requirement for their operations. One of the most crucial tasks a cash flow statement can complete is enabling businesses to determine whether they have an excess or deficit of cash. To reach their ideal cash balance, a company can invest excess cash, borrow money from outside sources, or find investors or lenders if they are in a deficit.
Working capital analysis
Working capital is the term for the cash that businesses currently have available to them—the sum of cash, deposits, or other reserves kept on hand to cover operational and ongoing costs. Business executives, investors, and other stakeholders can use cash flow statements to understand how a company’s working capital is moving. This analysis makes it simpler for a company to enhance its processes in order to protect cash and increase inflows.
Long-term planning
Cash flow statements, like short-term planning, can assist financial managers with long-term planning. A company’s ability to grow depends on accurate financial planning, and managers can spot specific, doable changes with the aid of a cash flow statement. These adjustments may eventually put the company in a sound financial position. In essence, a cash flow statement aids financial managers in understanding the priorities for a business.
Crisis management
A cash flow statement can aid in crisis management because it provides business stakeholders with information on whether they have a shortage or surplus of cash on hand. A manager may be able to think of ways to assist the company in overcoming such a challenge in advance if they can predict a potential cash shortage in the company’s future. This has a significant impact on a company’s capacity to achieve its objectives.
