What it is?
If you’ve been told that you need to do better with your finances, this post is perfect for you. It covers the basics of a cash flow statement – what it is, how to read it, and why it’s important – with self-explanatory visuals and bullet points. Keep reading if you’re looking for a clear explanation of the most crucial accounting document at a company…
The cash flow statement tracks where the money comes from and where the money goes. While the income statement is a great piece of accounting data, it doesn’t tell the whole story. CFOs and other senior managers also want to know about cash inflow and outflow since it can tell them about a company’s overall financial health.
In this article, we will talk about the three main reasons
Why you need a cash flow statement:
It’s an integral part of a company’s financial statements for reporting purposes. (According to U.S. GAAP, the guidelines for setting up financial statements, a cash flow statement is one of the five required elements.)
- It helps you track the changes in cash balance over time.
- It helps you analyze a business’s overall financial condition.
- Let’s look at these three main reasons in more detail.
1. A cash flow statement is essential for financial reporting purposes.
In short, a cash flow statement is the primary tool used by CFOs and other finance managers to analyze a company’s overall profitability and financial health.
Business uses the cash flow statement:
A business uses the cash flow statement (first 3 columns) to report its internal profit or loss and to show what it has used from its operating activities. This helps to reveal how well a company’s operations are making money for the business and for its shareholders.
The statement uses three columns to reflect the cash flow during a specified period:
- Cash Flow from Operations,
- Cash Flow from Investing, and
- Cash Flow Used for Financing.
The reason it’s split into three columns is that these 3 sources have completely different uses. The cash flow statement allows for an in-depth analysis of each source.
2. A cash flow statement helps you see where your money goes.
By tracking inflows and outflows of cash, you can make better decisions about where to allocate your money. Having a clear understanding of how much cash your business generates and uses on a regular basis will help you manage it more efficiently. You’ll know which expenses are essential to the success of your business and which ones can be outsourced or cut out altogether if need be.
Moreover, having a cash flow statement gives you an idea of how your business can afford to expand and grow. By analyzing the statements more carefully, you might realize that you need to raise some extra investment in order to expand. This information, in turn, will help you determine whether or not an expansion is feasible when it’s necessary, and what kind of financing options are available.
3. The cash flow statement helps you analyze a company’s general financial condition.
The cash flow statement allows you to check on the company’s overall financial health. It shows how the company is doing within its own accounting system. You can see how returns are being earned and to what extent they are backed by cash.
By comparing a company’s financials with its internal cash flow, you can determine whether or not the company runs out of funds at some point. If it does, then it gets into trouble (this is what analysts call a liquidity crunch). By looking at a company’s cash flow statement, you can also tell if the company has reached that point of being unable to meet its financial obligations. It’s not a bullseye for knowing when the company’s going to file for bankruptcy, but you will be able to see if there are any warning signs. The cash flow statement contains the following headings:
Debit & Credit – shows the amount of cash inflow and outflow.
(1) Cash From Operating Activities:
Shows the cash balance from the company’s revenue and expenses during the specified period. The amount of revenue is also included here.
(2) Cash From Investing Activities:
it shows all cash flow from investing activities, whether it’s in short- or long-term investments. It also includes cash used for purchasing other companies.
(3) Cash From Financing Activities
it shows all cash flow from raising or repaying debt or capital from stock or equity investors. It also includes cash receipts from issuing bonds or increasing shareholder’s equity.
In addition to the headings, there are three major sections in the Cash Flow Statement: operating activities, investing activities, and financing activities.
The following visual representations of cash flow statements will help you understand them in more detail.
- Section I: Cash Flow From Operating Activities
- Section II: Cash Flow From Investing Activities
- Section III: Cash Flow From Financing Activities
Where Should You Look First?
The key to analyzing a company’s cash flow statement is to look at the net change in cash. It’s also important to know what you should be looking at first and what information is more important than the rest.
The first thing you should look at is the operating activities column, where you will find such information as revenue, expenses, and cash. The second thing is to look at the investing activities section. Here you’ll see all sources of cash flow from investing: cash received from issuing bonds or increasing shareholder’s equity; cash used for investing in other companies; and cash used for purchasing other companies.
The next thing you should look at is the financing activities section. This is where you’ll find cash used for borrowing money and cash received from issuing bonds or increasing shareholder’s equity.
In addition, it might be a good idea to also look at changes in non-cash working capital, which can reveal a lot about how your business is doing and how well its operating system works. You can find some information on the Noncash Working Capital Explanation below.
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