The Importance of Cash Flow Statements (And How to Prepare Them)

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Cash makes the world go 'round. It's a critical part of doing business, and without enough cash coming in, it's almost impossible to do anything, from buying inventory to paying employees. Yes, credit can sustain you for a while, but when cash coming in doesn't exceed your expenses, there's a problem afoot.

However, analyzing cash flow isn't as easy as checking your bank balance or tracking recognized revenues; with an ebb and flow that's constantly moving, getting a handle on and improving your cash flow takes a little time and effort. A statement of cash flows is the best way to evaluate where your working capital stands – and what it means for the future.

What Is a Cash Flow Statement?

A statement of cash flows is essentially what it sounds like: a financial statement that summarizes the cash inflows and outflows over a certain period of time. A complimentary report to the balance sheet and income statement, a cash flow statement maps how a company is using its cash, and where cash is coming from. Unlike other financial reports, cash flow statements do not include any future expected cash payments, instead mapping only cash that has physically entered or left a company.

On a cash flow statement, cash is broken out into three categories: operating, financing, and investing activities.

  • Operating: Operating cash flow refers to cash movements that are derived from normal operating activities. For example, inflows include cash payments for products and services, while outflows include inventory purchases and payroll payments.
  • Financing: Financing activities relate to cash exchanges through the act of taking on debt, repaying debt, or paying dividends. For example, monthly loan payments made in cash would be considered financing outflows.
  • Investing: Investing activities are related to investments in a business, like asset purchases. If a company buys land or marketable securities, for example, these would be considered investing cash exchanges.

Cash flow can be tracked in one of two ways: direct method or indirect method. Direct method is a little easier, as cash is calculated by directly offsetting cash spent with cash earned, while the indirect method gets a little bit more granular as calculations start with net income and adjust for non-cash items, like depreciation and provisions for doubtful accounts. Due to the increased level of detail, most businesses record cash under the indirect method.

How to Prepare a Statement of Cash Flows

Simply put, a statement of cash flows begins with the starting cash balance at the end of a prior period and bridges to the current cash position. For example, if you had $1,000 in the bank on the first day of the month, spent $750, and received $1,250, your statement of cash flows will map out the comings and goings that get you to your current cash on hand – in this case, $1,500.

Most cash flow statements start with net income and work backward, first adjusting for things like depreciation and amortization and then incorporating cash activities in each of the three categories. Total cash flow is summarized at the bottom, in addition to ending cash balance for the period in question.

Accounting software such as Xero or QuickBooks Online can make a big difference in creating a statement of cash flows; with a few selected parameters, it's possible to run an accurate report in just a few clicks. Bookkeeping service providers such as Enkel can help manage the day-to-day bookkeeping tasks, allowing for easy generation of reports and statements.

Why Cash Flow Matters

Cash flow tells a valuable story, painting a more accurate picture of how your business is progressing behind the scenes. While strong revenue numbers are good, they aren't everything. Slow collections of accounts receivable can be a serious problem, leading to delinquencies and an inability to pay obligations. While this kind of situation can be endured short term, it can't last for long, leading to accelerating debt and, potentially, cessation of business.

An understanding of how cash comes and goes can help you reflect on the current course of business, but it also helps in planning for the future. Insight into how much cash you have on hand to pay future obligations allows you to best strategize for financing and investing activities, ensuring your expenses line up with cash you expect to have coming in.

A statement of cash flows can tell you a lot about what has already happened, and what's to come. If cash is a little light – or you have a big purchase you don't want to drain your cash to make – a business loan from Lendified may be the perfect solution.  You can always get a free quote and see what is available to you!

 

About the Author

Dene Paquin

Dene Paquin is the Marketing Manager at Enkel Backoffice Solutions, a Vancouver based accounting firm that provides day-to-day bookkeeping services for small and medium-sized businesses.