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What is a cash flow statement?

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A cash flow statement or a statement of cash flows summarizes all the cash and cash equivalents that come in and go out from a company. It can be expenses, benefits, revenue, profits, dividends, etc.

Together with the company balance sheets and income statements, a cash flow statement is one of the three pillars of financial records a company stands on. So, every company must make and maintain a cash flow statement. This guide will take you through the structure, benefits, and calculation of cash flow statements.

Why Do You Need Cash Flow Statements?

The statement of cash flow includes the principles of accounting. Accrual accounting means when the revenue and expenses of an organization are noted down or recorded when the transaction occurs, but not when they are completed.

This type of accounting is based on the matching principle. The principle states that revenues and expenses undertaken by a firm should be recognized in the same period. So, based on accrual accounting, here are some of the uses of a cash flow statement.

1. Liquidity

A cash flow statement tells you about the existing operating cash. It is essential to identify the firm’s current position when you want to check if you can afford to buy or invest in some asset. If the cash flow statement is not strong, it is strongly advised that you do not move ahead with the expense.

Source: Stockvalue

2. Shows your Firm’s Current Position

Since a cash flow statement records everything coming in and going out from your organization, it becomes imperative to maintain one. This is because it shows your assets, liabilities, and equity. By knowing these things, you will get an overview of your firm’s current position vis-a-vis the market.

These components are expressed in the form of cash outflows, cash inflows, and cash being held. As a result, you get an overview of your firm’s performance and potential.

3. Provides a Peak into the Future

By working on your cash flow statement analysis, you will get your company’s position corresponding to the future. By seeing the cash flow statement, you can get cash flow projections for the future. And this will also help you know your company’s future position, which is required to make long-term business plans. It can help reduce expenses and set a clear budget.

Other than this, a cash flow statement is a necessary document that you must include in your annual reports. It is even required when you want to apply for a loan or get a line of credit.

How To Use A Cash Flow Statement?

There are many uses of cash flow statements. In addition to the above-given purposes of the statement, there are a few other uses of the cash flow statement.

For one, it is used by the company officials, especially the ones who are working in accounting, to check the organization’s pulse. Since they will know the incoming and outgoing of money, it will help them make financial decisions accordingly.

In addition to this, investors will always want to look into the cash flow statement before investing. By looking at the statement, they can figure out the company’s position and decide whether they want to invest or not.

Institutional banks as well will require a statement before handing out a loan and the individual creditors will also want to look at it before lending money. The reason is simple; they want to know that the company can pay the money back.

Source: Flickr

What Is The Structure Of A Cash Flow Statement Like?

After understanding why you need a cash flow statement, let’s get into a breakdown of the components of the same. The list of items included in a statement can differ from company to company, but the outer structure is the same for every organization.

Operating Cash Flow or Cash From Operating Activities

Operating cash flow represents the money earned or spent in everyday business activities. It covers the sale of your products, services, etc., and the money you spend to sustain your business operations.

The activities included in the operating cash flow are not limited to service or product sales. But it includes many more components;

  • Payments made in interest.
  • Payments made for income tax.
  • Payments made to suppliers and other stakeholders for producing the product or service.
  • Giving salaries and wages to the employees.
  • Rental expenses – property, equipment, etc.

These components and many more like them make up the core structure of the cash flow statement. Based on the calculations involving these components and many more like them, a company finds the Net Earnings.

Net Earnings: This is what it all comes down to. The net earnings of an organization show the profit a company has earned in a certain period. To calculate the net earnings, we have to subtract the cost of goods sold (COGS) and expenses from total revenue. Expenses here refer to all the non-production-related expenses like rent, advertising, depreciation & amortization (D&A), interest paid, and so on.

The inclusion of the specific elements depends on the company and what it does. For instance, an investment company doesn’t have any tangible product to sell. But it still has non-production expenses like rent, ads, etc. But the difference is that in an investment company, the operating cash flow will include receipts of loans, equity, debt, etc.

The same in another company will come under expenses, but for an investment company, these are the earnings. Hence, the position of the components you add can also change according to the organization.

Cash From Investing Activities

As the name suggests, this is the money coming in from all the sources of the invested money. However, the term investment is not limited to the financial instruments but everything that brings value to the company. So, a sale and purchase of an asset will also come under this heading. In addition to this, we can include loans given to the vendors, merger payments, acquisitions, etc.

Source: Flickr

Technically, the accountants and finance people use two terms here;

  • Cash-out
  • Cash in

Cash-out is when cash is given to another entity for buying something. It can be some new tool, equipment, property, or even securities. However, when the same company’s assets are divested or sold, they turn into cash (Cash-In) because the firm receives the payment from the sale.

The basic principle is that a company replaces cash with an asset or an item they have bought with that cash. So, the product bought has the same value as the cash a company had in hand before buying.

Everything related to the cash flow from investment activities goes into the capital expenditures (CapEx) reports. So, within the CapEx, you will include the purchase of property, plant, and equipment.

Cash Flow From Financing Activities or Financing Cash Flow

Financing cash flow involves the activities related to the issuance or purchase of investment instruments. Things like stocks, bonds, dividends, interest make the list of financing cash flow. We can also include the long-term liabilities and equity held by the investing entity, which are reported in the company’s balance sheet.

Is Debt included in Cash Flow Statement under Financing activities?

Issuance of debt is one of the many instruments a company can utilize to raise capital for the finances. It is done because if a company has operational cash in hand, expansion becomes more manageable and quicker.

The thing with debt is that it does not guarantee any form of ownership to the lender. So, the company has to repay the debt according to the contractual obligation. When debt is taken, it is cash inflow and repayment of the identical amounts is a cash outflow.

What about Equity? How does Equity come under cash flow financing?

Issuance of Equity or selling some share of your company to an investor for money is also a cash inflow. However, with equity, you are giving up a predetermined share of ownership of your company. This means that the investor will also have some power to make the decisions.

But when you repay the equity amount, it is a cash outflow and called buyback because you are getting the ownership stake back from the investor.

Cash Balance

Cash balance tells you about your company’s position. In other words, it depicts the cash and cash equivalent held by your company, primarily consisting of the most liquid assets on the balance sheet.

Cash balance is the component that connects the cash flow statement to the balance sheet and income statement. Also, the concept of cash balance sticks to all three statements and provides a complete picture in the form of a Net increase in Cash or Closing Cash Balance and Opening Cash Balance.

  • Closing Cash Balance: This is the consolidated amount we get after considering the three components of the cash flow statement. At the end of each statement, you will get one figure, and the sum of these figures tells the increase or decrease in the cash balance. The amount thus calculated will be written in the balance in the Current Assets.
  • Opening Cash Balance: The closing cash balance of the previous year is the opening cash balance of the current year. This is the amount a company opens up and starts operating with the assets it has in hand.

Example of Cash Flow Statement

With the increased number of variables that must be monitored to maintain the cash flow record, you will find yourself dabbling with different methods for the same. The OneSlate platform brings an effective and reliable solution for business owners who want to stay updated with their cash flow at all times.

OneSlate lets you stay connected with your business’s cash-ins and outs while staying connected to Tally and record daily transactions. So, you can know your cash balance, collections, and liabilities, on a daily basis.

Slate Team

Slate Team

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