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A cash flow statement is also known as a statement of cash flows, it is a financial statement that shows how changes in the balance sheet affect cash and cash equivalents. The cash flow statement is an essential financial statement businesses prepare to handle their finances. The cash flow statement shows the viability of a company and its ability to pay bills. 

The cash flow statement can offer investors and analysts a portrait of a company’s transactions. The most important of all the financial statements of a company, the cash flow statement follows the cash made by the company in three main ways– through operations, investment, and financing. The sum of the three segments in the cash flow statement is called net cash flow. 

What is a Cash Flow Statement?

Essentially, the cash flow statement is concerned with the flow of cash that comes in and out of a company. The cash flow statement is the bridge between the two main financial statements: the income statement and balance sheet and shows how money moves in and out of a company. The cash flow statement is broken down into three different business activities: operations, investing, and financing. These three sections of the cash flow statement can help investors determine the value of a company’s stock or how the company is doing. 

What is the Purpose of a Cash Flow Statement?

The purpose of the cash flow statement is to show the inflows and outflows of cash during a reporting period of a company. These inflows and outflows of cash are classified as operating, investing, and financing activities of a company. The information in a cash flow statement is used by investors to determine the ability of a company to generate cash, and how the cash is used. 

What are the Three Components of a Cash Flow Statement?

The table below shows the three components of a Cash Flow Statement.

Operating Activities The operating activities of the cash flow statement show the operating costs and profit items that can also be found on an income statement. These include items such as accounts receivable and payable, inventory, wages payable, and income taxes payable. This section focuses on a business’s main activities, such as selling or buying merchandise and services. 
Investing Activities Investing activities on the cash flow statement report how much cash a company has generated or spent from various investment activities in a specific period. These can include such activities as purchases of physical assets, investments in securities, or the sale of securities or assets. The cash flow from investing activities shows the use of cash to purchase non-current assets or long-term assets that will provide value in the future. 
Financing Activities Cash flow from financing provides an overview of cash used in business financing. This measures cash flow between a company and its owners and creditors and is normally the cash flow from debt or equity. The cash obtained or paid back from capital fundraising efforts or cash flow from loans taken out or paid back are listed here. 

What is the Most Important Aspect of a Cash Flow Statement?

One of the three key reports that investors and other parties used to determine the financial health of a company is the cash flow statement. The income statement and the balance sheet are the other two reports that help to determine the financial health of a company. These reports are required by the Securities Exchange Commission (SEC) in the US.

The cash flow statement is an essential report for a company because it provides important context to information that might not be apparent on a different financial statement. For example, sales normally go on a company’s income statement and contribute to the company’s overall profit or loss. However, the cash from the sale may not show up in the company’s bank account for months if the invoice wasn’t due immediately. This is why it’s important to understand how cash flow works within finances. 

When is a Cash Flow Statement Required?

The cash flow statement is one of three financial reports which also include the balance sheet and the income statement. Financial statements are often audited by government agencies, accountants, firms, etc. to ensure accuracy and for tax, financing, or investing purposes. These statements are normally required during a fixed period of time. 

Who is in Charge of Creating the Cash Flow Statement?

The cash flow statement is a financial report that is generated at a particular point in time to show a company’s financial status. The financial report is one of three reports that are set up by the accountant. 

What are the Methods of Calculating Cash Flow Statement?

A cash flow statement tracks financial transactions in three major areas during a given period. These three areas are; operating activities, investing activities, and financing activities. The sum of all these areas together is referred to as “the net cash flow” of a business. Net cash flow is the total amount of money that a business has for that period. A positive number means that the business is bringing in more cash than it is spending. 

To calculate cash flow, you must adjust a company’s net income by increasing or decreasing the differences in credit transactions, expenses, and revenue between reporting periods. It’s important to make these adjustments because non-cash items are also included in the net income on the income statement and the total amount of liabilities and assets on the balance sheet. Since so many transactions involve non-cash items, you have to alter how you calculate their effect on cash flow. 

There are two different ways to calculate cash flow. These include the direct method which lists all of the cash transactions, including payroll expenses, payments from customers, and vendors’ expenses. This method uses the beginning and ending balances of different business accounts to examine net decreases or increases for each account. The indirect method for calculating cash flow starts with the company’s net income, which is taken from the income statement. An income statement is extremely limited, so you must make adjustments to account for things like earnings before interest and taxes, also known as EBIT. 

How a Cash Flow Statement is Used to Analyze a Business.

A cash flow analysis helps you examine how a business is generating and spending money over a specific period of time. It helps you figure out where your money is going and how much cash you have available at a given period. You’ll need to prepare your cash flow statement first in order to perform a cash flow analysis. As mentioned before, a cash flow statement consists of three main sections: operating activities, investing activities, and financing activities. 

Cash from operating activities represents cash received from customers less the amount spent on operating expenses. Investing activities reflect funds spent on fixed assets and financial instruments. Financing cash flows is funding that comes from a company’s owners, investors, and creditors. When doing a cash flow analysis, it is important to watch out for trends and outliers that will tell you a lot about the financial health of the business.

Listed below are ways to analyze a business using a cash flow statement.

  1.      First, aim for positive cash flow. It is important to have operating income exceed net income. This is a strong indicator of a company’s ability to remain solvent and sustainably grow operations. 
  2.      Second, be circumspect about positive cash flow. Positive investing cash flow and negative operating cash flow could signal issues. It could indicate a company is selling off assets to pay its operating expenses. 
  3.      Third, analyze your negative cash flow. Negative cash flow doesn’t always mean a bad thing. It could be that the business is making investments in property and equipment to make more products. 
  4.      Fourth, calculate your free cash flow. Free cash flow is what you have after you pay for your operating expenditures and capital expenditures. This can help pay down principal, and interest, buy back stock, or acquire another company. 
  5.      Lastly, the operating cash flow margin ratio measures cash from operating activities as a percentage of sales revenue in a given period.  A positive margin demonstrates profitability, efficiency, and earning quality. 

What are the Cash Flow Statement’s Limitations?

There are some limitations to the cash flow statement which prevent it from showing a complete picture of a business’s financial position. This is because the cash flow statement shows only cash inflow and cash outflow, but the cash balance disclosed by the statement cannot reveal the true liquid position of the business. Also, the net cash flow disclosed by the cash flow statement does not necessarily mean the net income of the business because net income is determined by taking into account both cash and non-cash items. 

The cash flow statement does not help in knowing the future or projected cash flows since it is prepared on the basis of historical cost. It is also not possible to assess the profitability of a business since it neither considers the costs nor revenues of that business. There is also a lot of room for error when preparing the cash flow sheet since it is based on the balance sheet. If the balance sheet is wrong, the cash flow statement is also wrong. 

Is Cash Flow Same as Profit?

Cash flow is not the same as profit. Cash flow is the inflow and outflow of money from a business. It is necessary for the daily operations, taxes, purchasing inventory, and paying employees and operating costs. Where profit is the surplus, after all, expenses are deducted from revenue. Profit shows the overall picture of a business and the basis on which tax is calculated.