The cash flow of a company is the total incoming and outgoing flow of cash during a fixed time period. It includes all transactions during that particular time period and a statement is made listing all the cash flows. This statement is known as the cash flow statement.
In this blog post, we discuss the basics of cash flow and the preparation of cash flow statement.
Every transaction in the company, virtual or real, is recorded into three categories of activities and stated in the cash flow statement in three different sections. Before we leap into the cash flow statements, let’s be clear about the cash flows and its implications in a business model.
Cash flows include all the possible transactions inside a company. An accurate assessment of the cash flows will help to determine if the company is able to generate enough cash and stay liquid. Positive cash flow is an indication of an increase in assets and the company’s abilities to:
- Settle the debts
- Pay stakeholders
- Meet expenses
- Prepare for future plans
Sometimes, the profits of the company can be stuck in accounts receivables and inventory. These amounts do contribute to the total assets of the company but may remain invisible as real cash for a time period. Having all these amounts calculated and listed in a document will help in understanding the company’s standing on financial terms. This will also help potential investors and stakeholders to assess the company’s capability to clear current liabilities and future growth.
Free cash flow is another term which you’ll hear more often when talking about cash flows. This is the representation of the cash a company generates after all the expenses. Free cash flow is yet another important indicator of a company’s growth.
Cash flow is a major determinant for attracting investors and stakeholders, and an overall assessment of the company's financial performance. Let’s look into how to prepare cash flow statements.
Cash Flow Statements
Cash flow statement is a record of all the cash flows or financial transactions inside the company. Cash flow statement includes three sections where cash flows are categorized depending on:
- Operational activities
- Investing activities
- Financial activities
The first section, Cash flows from operational activities, start with the net balance from the balance sheet and includes all the cash and non-cash transactions from operational activities. Accounts receivables, accounts payable, depreciation, amortization, etc come under operational cash flow statement. In general, operational cash flow indicates all the revenues and expenses during a time period.
Cash flows from investing activities mainly come from purchase or selling of assets such as property, plant or equipment. We get the net cash flow before financing activities by adding operational and investing cash flows.
Cash flows from financing activities forms the last section of the cash flow statement. Transactions in this section are generated from financial activities such as funding and loans, buying shares, paying debts, etc.
The sum total of the cash flows from all the three sections will give the net cash movement during a period of time.
How To Prepare A Cash Flow Statement
There are two ways to prepare a cash flow statement- direct and indirect.
The main difference in both these formats comes in the cash flow statement from operational activities. The indirect method makes use of variables to calculate the cash flows. It starts with the net income and makes adjustments with respect to assets and liabilities to reach the operating cash flow. Whereas, in the direct method of cash flow statement, cash receipts and payments are listed during a time period. The cash outflows are subtracted from the cash inflows to arrive at the net cash flows from operational activities. The final amount listed using both these methods is the same, however, the calculating method is different.
Cash flow statements give a complete picture of your company’s status on cash flows for a time period. These detailed documents help you track down the cash distributed among various activities. At times, small businesses and enterprises face a cash crunch with no knowledge of its real cause. An assessment through the cash flow statements helps owners understand the channels of expenditure and make better decisions.
Keeping an online cash flow statement helps easy integration and understanding in such situations. Accounting software like Xero and Quickbooks are designed for this and it keeps the record updated. Most financial institutions, like Finaxar, have an online application process to cope up with the business pressure in times of low funds.