Successful businesses emphasise robust financial tracking and reporting, and a major area of concern for any business is its cash flow.
Financial reports of business organisations comprise various components like income statements, balance sheets and cash flow statements. Out of these, a cash flow statement helps a business track cash movement in the organisation. The statement also provides valuable insights into the impact that the cash flow has on the business.
Maintaining a cash flow statement is mandatory for any business organisation. With a proper cash flow statement, a business can conveniently find out what is coming in and going out.
Read on to learn more about the significance of a cash flow statement in the business scenario.
What Is a Cash Flow Statement
People use different terms for a cash flow statement like cash flow report, statement of cash flow, consolidated statement of cash flows, and so on. Broadly speaking, a cash flow statement reflects the total calculation of the cash amount flowing in and out of a business organisation. It depicts the cash management of the business organisation.
Various factors contribute to cash moving in and out of a business. However, these factors may not directly relate to product sales, goods and services. The cash in the cash flow statement also includes cash equivalents like short-term investments or assets like cash in savings, current accounts, etc.
Components of Cash Flow Statement
There are three sections in the cash flow statement, namely operating activities, investing activities and financing activities. The incoming and outgoing money is from these activities.
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Operating Activities
One of the most crucial information on the cash flow statement, operating activities are the primary sources of cash generation for the business organisation. This part of the statement displays the cash the company’s core services and products generate.
A strong and positive cash flow from these activities implies good business health.
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Investing Activities
This segment of the cash flow statement records all kinds of changes in assets, investments and equipment.
When it comes to investing, it is generally ‘cash outflow’ for the business. The cash is used to purchase assets (long-term and short-term), buildings, equipment, etc. A successful company usually invests in land, equipment and mostly fixed assets.
However, a company might need to divest some assets or land. The transaction will be considered a ‘cash inflow’ in such a case.
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Financing Activities
Items listed under financing activities include long-term borrowings, changes in loans, debt or stock options, etc.
A rise in capital is ‘cash in’, while payment of debt or dividends is ‘cash out’. This section of the cash flow statement displays the impact of borrowing on the cash flow of a company.
Interpreting a Cash Flow Statement and Determining the Financial Health of a Business
As a newbie in accounting and finance, you must know how to read and interpret a cash flow statement. The first thing you must remember is to review the cash flow statement from a business perspective. You can learn about an organisation’s financial status and health through these financial documents.
Positive and negative cash flow:
In the cash flow statement, the figures within parentheses denote the money spent, also referred to as the negative flow of cash. On the other hand, figures without parentheses are the amounts of money received or positive inflow of cash.
When the overall cash flow for an accounting period comes out to be positive, it indicates that the business organisation is generating cash well and the business is doing well. On the contrary, a negative cash flow indicates just the opposite.
However, a negative cash flow is not always unhealthy. If a company is new and developing, a negative cash flow can be attributed to a strategic growth plan or purchasing assets and equipment for the company’s growth.
Understanding the financial health:
A cash flow statement displays the financial health of a business organisation as it presents both the cash earned and cash spent in a given period. This tool helps measure the company’s potential to cover its expenses in the coming financial/accounting term.
The cash flow statement analysis also helps understand the company’s cash flow trend. Various financial decisions take shape depending on this analysis.
Conclusion
The best tools for evaluating a company’s financial health are the balance sheet, the income statement and the cash flow statement. Many organisations overlook the cash flow statement, but the importance of this financial statement cannot be undermined. Cash flow statement analysis helps a company improve its credit-decision process and other financial decisions.
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FAQs
- How is cash flow calculated in a business?
Net cash flow in a business is calculated as the difference between the total cash inflow and cash outflow.
Net Cash Flow = Total Cash Inflow – Total Cash Outflow
- Is the cash flow statement prepared monthly or annually?
A business organisation prepares a monthly cash flow statement in the first year. The cash flow statement can be prepared quarterly or annually when the business stabilises.
- Is cash flow and profit the same in a business?
Cash flow and profit are two entirely different things in a business. Cash flow determines the flow of money in and out of business. On the other hand, profit is what remains from revenue generated after deducting the costs.
