A cash flow statement, also known as the statement of cashflows, tracks the total flow of cash in and out of a business. It summarizes the likelihood of a business being able to meet any payment and debt obligations, and its ability to cover expenses. The CFS is one of the three main financial statements, working alongside the balance sheet and income statement.
A cash flow statement, also known as the statement of cashflows, tracks the total flow of cash in and out of a business. It summarizes the likelihood of a business being able to meet any payment and debt obligations, and its ability to cover expenses. The CFS is one of the three main financial statements, working alongside the balance sheet and income statement.
Essentially, the cash flow statement will focus solely on cash activity, such as cash from sales, cash spent on operational costs, cash from financing, whether it be cash received as investments or paying lenders, and more. It only tracks items that have been paid or received, giving a clear picture of cash movement and activity.
Whereas, the income statement and balance sheet can contain non-cash transactions, such as accruals and prepaid expenses. This can make it difficult to understand what items are impacting your cash balance.
There’s two methods of reporting cash flow statements, which use their own method for categorisation:
The direct method: showcases cash flow in categories such as cashflow from customers and suppliers.
The indirect method: which categorizes cash flow into three categories, investing activities, financing activities and operating activities. This is the accepted method under the Generally Accepted Accounting Principles (GAAP), therefore it’s preferred when issuing to third parties such as banks and investors.
Furthermore, the indirect method of preparing a cashflow statement looks to reconcile cash at the beginning of the period to cash at the end of the period by categorizing transactions and pinpointing adjustments. Cash flow statements work when beginning cash plus the sum of operating, investing, and financing activities equals your ending cash balance.
This statement is commonly prepared on an annual basis, but if you are looking for granular insights, weekly, monthly, and quarterly reporting can be done. Additionally, many accounting software programs can generate this statement for you, or you can find a cashflow statement template online.
Cashflow from operating activities will usually have the most data, as it showcases how much cash a company is generating based on its operating activities. This section starts with net income, then showcase line items such as expenses, revenue and funding. Certain income statement items will be blacked out, such as a non-cash loss on the sale of a fixed asset, depreciation, amortization, and changes in working capital.
Cashflow from operating activities also contains changes in balance sheet accounts, such as:
When considering the valuation of assets, increases in asset accounts between periods will be represented as a negative, while decreases will be a positive. The opposite is true for liabilities. Decreases in liabilities are represented as a negative and increases are positive. Determining the amounts of adjustments relies on having financial reports from the prior period.
Here’s a cash flow statement example that demonstrates the operating activities section:
Let’s say that net income for the year was $10,000 and the business had the following transactions: an increase in accounts receivable of $500, a decrease in accrued liabilities of $250, and depreciation of $1,000.
The net cash provided by operating activities would be $10,000 – $500 – $250 + $1,000, or $10,250.
A good place to start when trying to piece together cashflow from operating activities is to look at your financial statements. If you are using accounting software, you should be able to create a report but it’s always important to double-check your numbers for accuracy.
Section two on the cash flow statement is cashflow from investing activities, which contains transactions that relate to cash (inbound or outbound) from long-term investments. This is commonly the purchase of fixed assets, investment in securities, the sale of securities and/or assets.
Specific business activities will determine which types of line items are found in this category. For example, if it’s a manufacturing business, activities could include fixed assets, such as the purchase of new equipment each year. On the contrary, if the business is a brokerage, it’s most likely the purchase of securities will be listed.
The balance sheet will be an important resource when piecing together cash flow from investing activities. It’s also important to note no liabilities will be listed in this section.
Let’s go through a few cashflow statement examples:
A business purchased $50,000 of equipment and sold $10,000 of investments. What would the cashflows from investing activities be? Purchases are subtractions, or negative numbers, while sales are represented as positives. By subtracting $50,000 of fixed asset purchases from the proceeds of $10,000, net cash used from investing activities will be ($40,000).
This is where all transactions and changes in account balances related to financing, such as lines of credit and loans, are listed. Financing activities will also contain changes in stock ownership and distributions. For example, if a business bought out one of its shareholders, this transaction would be listed in this section.
Payments on loans, buyouts, the purchase of treasury stock and distributions are all represented as negative numbers. On the contrary, proceeds from loan issuances or capital contributions by shareholders will be positive numbers, indicating cash is coming into the company. Note and reminder that interest associated with any loan payments will be found above in the operating activities section.
Let’s look at an example:
A company took out a new loan for $100,000. They have made $10,000 of principal payments on the loan. In addition, they distributed $50,000 to shareholders in the current year and paid down a line of credit by $25,000. What would the net cash provided by financing activities be?
The new loan proceeds would be a positive cashflow transaction; however, the $100,000 must be reduced by the $10,000 of payments made, showing a net line item of $90,000 on the cashflow statement. Then, the distributions of $50,000 and line of credit payments of $25,000 would be represented as negatives.
The net cash flow provided from financing activities is $15,000 ($90,000 – $50,000 – $25,000).
The cash flow statement provides indispensable insights into a company. After taking the time to piece together this statement, the next step is to review what the numbers actually have to say. With proper analysis, cashflow statements can indicate liquidity and how a business can effectively use the cash on hand to grow or improve its financial position.
When looking at the operating section, it’s important to review how money is being moved. If the accounts receivable balance is decreasing, it might indicate sales are slowing, customers aren’t financing purchases, or internal payment collection need improving. Understanding cash movement in the balance sheet is essential to forecasting and planning for upcoming periods.
The same is true for investing and financing activities. If a business notices proceeds from bank notes and loans are constantly increasing, it can indicate cash flow issues. This makes it important to ask why the money needs to be borrowed? Is it to reinvest in efficient equipment or because customer demand is shifting? Understanding the financial health of an organization is critical to reach its operational and financial goals.
In many cases, the cash flow statement is used in a business setting, but that doesn’t mean it can’t apply to personal finances. You can use the same types of categories for your individual cash flow projection. Your operating section might contain day-to-day transactions, like groceries, while your investments might be in retirement accounts and real estate. Additionally, your finance section might contain all your loans and credit cards.
Regardless of how we use a cash flow statement, it’s a critical document that can help with planning in both the short term and long term. Cash flow statements make it easy to identify specific and implementable changes that set the foundation for financial growth and improved stability.
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