As business owners, we must be able to identify and understand how cash is moving through our organisation. It’s the only way we can keep tabs on what’s coming in, what’s going out, and how much money there is left to spare!
Your cash flow statement will likely provide you with all the information you need in this respect. But how does it work, and what can you actually learn from it? Read on for my quick guide!
What is a cash flow statement, in its most basic form?
A cash flow statement is a financial report that tracks the cash inflows and outflows of a business over a specific period, divided into operating, investing, and financing activities.
This statement is essential for understanding how your business generates and uses cash, because it can provide insights into your liquidity, financial health, and overall stability. It is one of the three core financial statements, alongside the profit and loss statement and balance sheet, and it provides a clear view of a company’s cash position by separating cash flows into different activity categories so you can analyse how efficiently you are managing your cash.
How do cash flow statements work?
Cash flow statements categorise cash transactions into three main sections:
- Operating activities: This is your cash flow from day-to-day business operations, such as sales revenue, payments to suppliers, payroll, rent, and taxes.
- Investing activities: This is the cash flow related to acquiring or disposing of any long-term assets, like purchasing or selling equipment, property, or investments.
- Financing activities: This is the inflow and outflow from financing actions, including loans, issuing or buying back shares, and paying dividends.
You can calculate your net cash flow by adding the net cash from all three sections together. A positive net cash flow means your business generated more cash than it spent, while a negative net cash flow suggests that there’s too much exiting the company, and too little coming back in.
What are the key components of a typical cash flow statement?
Direct vs. indirect methods
Cash flow statements can be presented in one of two ways. The direct method lists specific cash transactions, such as receipts from customers and payments to suppliers, whereas the indirect method adjusts net income for non-cash transactions, starting with net income and adjusting for changes in working capital and non-cash expenses (for example, depreciation). The indirect method is more widely used, but the direct version can provide more information about where the cash is coming from.
Depreciation and amortisation
These are non-cash expenses that appear on the profit and loss statement but are adjusted in the cash flow statement, as they don’t involve the movement of actual cash.
Working capital adjustments
Any changes in accounts receivable, inventory, and accounts payable reflect the day-to-day financial activity that impacts your cash flow, so these need to be added quickly and accurately.
What kinds of insights can you get from your cash flow statement?
Your cash flow statement can help you analyse:
- Liquidity – Whether you have enough cash to meet your short-term obligations, which is obviously critical for your day-to-day operations
- Profitability vs. cash flow – Your business might be profitable on paper (when you look at your profit and loss statement), but you might still have cash flow issues due to delays in receivables or high operating costs. Your cash flow statement will clarify your actual cash position
- Operational efficiency – By analysing cash flow from your operating activities, you can work out whether your operations are self-sustaining or if they rely heavily on external financing
- Investment and growth potential – Because tracking cash flow in investing activities shows how much is being spent on growth or long-term assets
- Financing health – The financing section of your cash flow statement will reveal your company’s reliance on debt or equity, and whether it can afford to comfortably service debt or pay dividends
- Financial risk – Consistent negative cash flow could mean you’ll have trouble operating sustainably or paying off debts in the future!
As you can see, cash flow statements can help you, as the business owner, better understand your company’s financial performance, and identify any areas for improvement.
They are also a useful tool for investors and lenders, who will want to see that you’re working to a consistent, positive cash flow before committing to any dealings with you, and will need to see as much documentation as possible before they reach their decision on what deals and terms to offer you. These third parties might see from your profit and loss statement that you’ve got strong profitability, but after digging a little deeper in your cash flow statement, they might find that you’ve got negative cash flow from your activities, perhaps because you’re waiting for lots of invoice payments to come in.
Essentially, your cash flow statement will give you a real-time view of your company’s cash health, plus plenty of practical insights to help you better manage your operations and fund growth.
