What are cash flow statements?


Cash flow statements are documents detailing your financial performance. By summarising the cash and cash equivalents, you can see the company's financial health. 

Like the profit and loss, and income statements, understanding cash flow statements is one of the business essentials. However, it differs from other accounting methods as it isn't as affected by non-cash items.

Let's get to the following commonly asked questions:

  • What is a cash flow statement?
  • How to set up a cash flow statement?
  • What is the importance of a cash flow statement?
  • Does depreciation go in a cash flow statement?
  • Does prepaid rent go in a cash flow statement?
  • Are dividends included in a cash flow statement?
  • How to prepare a cash flow statement using the direct and indirect methods?
  • How often are cash flow statements prepared?

The three main areas of cash flow statements (CFS) are cash from financing, cash from investing, and cash from operating. This article will take you through cash flow statement examples and how to set up your own cash flow statement template.

Q1: What is a cash flow statement? 

Firstly, cash flow is the cash going in and out of your company. Often, cash inflow is money from sales. 

Nevertheless, it could also include debt repayments, selling assets, rebates, and grants. Cash outflows are typically payments to suppliers, wages, bills, maintenance, and operating expenses. 

Your cash flow statement shows the cash and cash equivalents your company generates over a certain period. It's an essential addition to the balance sheet and income statements. 

However, unlike the income statements and balance sheets, it is an accurate measure of money moving into and out of the organisation. Plus, it's essential for any business trying to work out a budget.

Important: Cash flow statements follow the International Accounting Standard Board's acceptable accounting principles.

Q2: How to set up a cash flow statement?

The main components of a cash flow statement include:

  • Cash flow from operating activities: Operating business activities is how much income is generated from products or services.
  • Cash flow from financing activities: Any sources of income from investment business activity. 
  • Cash flow from investing activities: Includes cash from investors, banks, shareholders, dividends, and debt principal. 

Non-cash activities are also sometimes included under the accepted accounting principles GAAP.

You can calculate cash flow statements through one of two methods: the indirect and direct methods. We'll come back to these later in more detail. 

Important: A glance at your cash flow statement will tell you how much cash your company has and can help organise payments and save money.

An example of a cash flow statement

The general cash flow statement template opens with the organisation's net earnings. Then, it will detail the additions to cash and the subtractions. 

The former might include depreciation, increase in accounts payable, decrease in accounts receivable, an increase in taxes owed. The cash subtractions will list the increase in inventory. 

Next is the operating section, cash flow from financing activities, flow from investing activities, and notes payable. 

Finally, the statement will show the cash balance for the covered period.

Note: Cash flow statements indicate which activity brings the most positive cash flow. If the cash flows from operations are the most significant inflow, it'll reassure investors.

Q3: What is the importance of a cash flow statement?

Statements of cash flow are an integral part of accrual accounting. It provides business insights, assists financial analysis, and helps understand how a business operates.

Firstly, cash flow statements show your liquidity, how much you can afford and what you cannot. 

Secondly, the statement shows you your current assets, current liabilities, and equity changes. Your inflows, outflows, and cash are held to form the basis of your accounting standards.

Finally, cash flow statements enable you to predict future cash flows. Liquidity is vital for long term business planning. You can create projections to plan for how much liquidity you will need in the future.

Negative cash flow vs. positive cash flow

What's the difference between negative and positive cash flow? Well, when your statement has a negative number under cash balance, your capital expenditures outweigh positive flows. You have a negative cash flow; you made a loss in that period. 

Yet, negative cash flows aren't inadequate in the long term. Startups often make losses before their flows from operating activities turn a profit.

When the cash balance is positive, you have a positive cash flow, and your business is more liquid as it can meet debts. Having an abundance of liquidity is not always good. That's because it can be a sign that a business is not investing enough in the growth of a business.

Q4: Does depreciation go in a cash flow statement?

Depreciation is included in your monthly expenses. However, as you have paid cash for the asset, it doesn't negatively affect your net cash flows. 

You record it on your monthly cash flows to see the total expense of the asset throughout its life. But, the cash isn't leaving your account each month. 

Q5: Does prepaid rent go in a cash flow statement?

Prepaid costs are expenses that have been paid ahead of the month. Prepaid rent will go under your increase in the accounts payable section. =

While prepayments might seem like a good idea, they can significantly impact your business position if you have marginal cash flow. Decreasing your prepayments will improve your working capital and cash flow.

Operating expenses are primarily paid month to month. Therefore, reducing prepayments will benefit cash flow for the current month.

Q6: Are dividends included in a cash flow statement?

Dividends received will go in the cash flow from the financial activities section. As dividends are considered liabilities rather than assets, they don't affect your cash flow until issued. Then, they're recorded as an outflow when dividend payment is approved and issued. 

Q7: How to prepare a cash flow statement using the direct and indirect methods?

Direct and indirect are different methods of calculating cash flow. The difference lies in the ways accountants calculate them. The direct method, for example, uses known cash inflows and outflows. It's a straightforward method, using cash receipts. 

The direct method is often easier for smaller businesses that use a cash basis accounting strategy.

On the other hand, you do not need to know the actual operating cash flows with the indirect method. The indirect cash flow method uses the net income or loss from the income statements and balance sheet to modify the figure. 

The indirect method is better for companies using the accrual basis accounting strategy. Accountants can determine the amount of net cash flow by looking at a decrease or increase in accounts receivable. If it has decreased, this implies that cash has entered the company. Therefore, it's added to net cash flow. 

On the other hand, increases in inventory on the balance sheet and income statement imply cash has moved out of the company. Therefore, it's subtracted from net income. 

Note: The International Accounting Standard Board prefers the indirect method. However, the majority of smaller businesses use the direct approach.

Q8: How often are cash flow statements prepared?

Often, businesses calculate cash flows every month. That's because many expenses, assets and liabilities are billed monthly. Hence, it's an excellent time to assess cash flow from operations, investing, and financing. 

There is no rule to say how often you should prepare a cash flow statement. Younger businesses should prepare them more frequently, perhaps as often as weekly in the first year. 

For some organisations, quarterly cash flow statements should be acceptable. Larger companies might be able to get away with yearly cash flow statements. 

In summary

Statements of cash flow are integral to every business' understanding of their expenses and cash income. They benefit investors, shareholders, and might be helpful if you're applying for credit. Every company should have a firm idea of their operating, investing, and financing activities. 

While investors like to see a positive cash flow, remember, don't be put off by a negative cash flow. Often, negative cash flows can have better long term expansion results than positive cash flows. 

It is a valuable measure of liquidity and can help you plan for the future. Overall, it is crucial to understand the organisation's financial health and future success.

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Disclaimer: The author is not a financial advisor and the information provided is general in nature and was prepared for information purposes only. This article should not be considered to constitute financial advice. Accordingly, reliance should not be placed on this article as the basis for making an investment, financial or other decision. This information does not take into account your investment objectives, particular needs, or financial situation.

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