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The cash flow statement’s impact on managing a business is enormous. It tracks spending and forecasts near-term cash flow to meet short-term goals. It informs long-term budgeting. It helps management prioritize essential activities. The cash flow statement is a crucial tool in valuing a company and understanding its operation.

 

The cash flow statement is an important document that provides a wide-angle view of a company’s operational, financial, and investing activities. Yes, the cash flow statement covers a lot of ground, but we’ve created the following post to shorten your learning curve.

 

Takeaways

  • How the cash flow statement helps a company make informed decisions for managing business operations.
  • Why an accurate cash flow forecast helps companies predict future cash positions, avoid debilitating cash shortages, and earn returns on any cash surpluses they may have.
  • The 15 ways a cash flow statement can help a company.
  • The 3 financial statements for measuring a company’s strength.
  • What makes a good cash flow statement.
  • Whether profit is more important than cash flow.
  • Does positive cash flow always mean profit.

 

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What is cash flow management in business?

Managing and understanding cash flow in business is easy if you think of it as the money that comes into your business (cash inflows) with the money that goes out (cash outflows).

 

Cash flow management is a process of tracking, analyzing, and optimizing the money you receive through sales, for example, with the money you give out when you pay bills, salaries, or taxes.

 

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What is a cash flow statement?

The cash flow statement is one of the most important financial statements issued by a company. Used to manage finances by tracking the cash flow for an organization, the cash flow statement shows the source of cash and helps you track incoming and outgoing money.

Incoming cash for a business comes from operating activities, investing activities and financial activities — the sum of which is called net cash flow. The statement also informs about cash outflows, expenses paid for business activities and investment at a given point in time.

 

The cash flow statement helps a company make informed decisions for managing business operations. The cash flow management tool is an essential tool in determining how well a company can earn cash to pay its debts and manage its operating expenses.

 

Cash flow analysis

A cash flow analysis determines a company's working capital — the amount of money available to run business operations and complete transactions. That is calculated as current assets (cash or near-cash assets, like notes receivable) minus current liabilities.

 

Cash flow projections

Cash flow forecasting is the process of estimating the flow of cash in and out of a business over a specific period of time. An accurate cash flow forecast helps companies predict future cash positions, avoid debilitating cash shortages, and earn returns on any cash surpluses they may have in the most optimized manner possible.



Cash monitoring is a tough task for small businesses like us... with Plooto, we now know exactly how much money is being paid-out and when, so we have full visibility into our cash flow management. Plus, we save over 40 hours a month by removing all the previous manual steps in our Accounts Payable process.
Greenhouse Juice Co.

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What are the 3 types of cash flows?

Three types of cash flows are included on a company’s cash flow statement and are used to determine a business’ liquidity and solvency.

 

1. Operating cash flow

Operating cash flow activities include accounts receivable and payable, inventory, wages payable and income taxes payable. Operating cash flow focuses on the business's main activities, like selling or buying merchandise and services.

 

2. Investing cash flow

Information about the business's purchase or sale of long-term investments — property, buildings, vehicles, furniture or equipment — fall under investing cash flow. The investing activities section provides further details about a company's assets.

 

3. Financing cash flow

This section details all cash transactions from long-term liability and stockholder equity accounts, including notes payable, retained earnings and dividend payments. Financing cash flow activities section shows the company's net cash flow, taking into account stock purchases and debt financing.

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Why is a cash flow statement important?

The cash flow statement is a solid measure of a company’s strength, profitability, and future outlook of a company. The importance of the cash flow statement is that it measures the cash inflows or cash outflows during the given period of time. This knowledge informs the company’s short- and long-term planning. It also helps in analyzing the optimum level of cash and working capital needed in the company.

 

Because cash flow statements provide a detailed report on how much cash a business has on hand at a given time, the company can use the cash flow statement to:

  • Project the cash flow in the near future and keep track of spending to meet specific, short-term goals.
  • Inform long-term budgeting by predicting future cash flow by using past data of the cash inflows and outflows.
  • Help management prioritize essential activities.
  • Eliminate waste and reduce expenses. Cash flow statements show whether specific functions, tasks and strategies are working, need improvement, or should be cut.
  • Provide insight — a detailed portrait of cash outflows — into spending activities.
  • Identify opportunities to create additional cash, e.g., use the inventory more efficiently, invoice customers sooner or more frequently, collect customer payments faster.
  • Determine the optimum level of cash balance, enabling the company to invest excess cash and at the same time have sufficient liquidity for future needs.
  • Analyze and manage working capital — are you meeting your short-term obligations and capitalizing on your assets.
  • Better evaluate cash planning results. A cash flow statement can help companies analyze whether their cash planning was actually effective by allowing readers to compare projected cash flow numbers to actual cash flow results.
  • Know the optimal cash balance they need to operate the business successfully.
  • Project major problems in advance requiring crisis management.

Because the cash flow statement casts light on the different areas where a business used or received cash, it’s an essential financial statement when it comes to valuing a company and understanding how it operates.

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What does the cash flow statement not include?

While the cash flow statement is an important tool used to manage finances, it does not provide a complete picture of the company’s health and viability:

  • The cash flow statement excludes expenses that are not paid right away. Only when payments are made toward company liabilities do these liabilities become recorded as a cash flow.
  • The cash flow statement does not show the profit earned or lost during a particular period — profitability is composed of cash earned but also of non-cash items: capital depreciation or investment gains, for example.
  • Liabilities and assets are not accounted for in the cash flow statement, but are recorded on the balance sheet.
  • Accounts receivable and accounts payable are also not reflected in the cash flow statement.
  • The cash flow statement excludes non-cash transactions required by accrual basis.
  • Accounting, such as depreciation, deferred income taxes, write-offs on bad debts and sales on credit where receivables have not yet been collected.

The cash flow statement is part of a group of business statements that can help you measure and understand your company’s performance and — if needed — guide changes in operations and strategies. The cash flow statement can help investors better understand if they should invest in the company.

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3 Financial statements for measuring a company’s strength

Typically, a company uses the following three financial statements to document its financial data, and present a more accurate picture of its overall financial health and underlying value.

1. Balance Sheet

The balance sheet details a company's assets, liabilities and shareholder equity.

2. Income Statement

The income statement records a company's net income or net loss. Companies use the income statement to track all revenue coming in and all expenses going out.

3. Cash Flow Statement

The cash flow statement records all incoming cash flow from business operations along with all outgoing cash flow to pay for expenses and operational costs.

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What’s the difference between income statement and cash flow?

A cash flow statement provides a detailed picture of a company's cash inflows and outflows over a period of time. The income statement measures a company's financial performance — such as revenues, expenses, profits, or losses — over a period of time.

 

Are you interested in knowing whether the company make a profit? The income statement will tell you. If you’re interested in knowing the sources of a company’s cash and its uses of cash over a specific period of time look at the cash flow statement.

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How is a cash flow statement prepared?

A cash flow statement breaks down the various types of inflows and outflows of cash (and cash equivalents) that a business experiences. Done well, a cash flow statement should:

 

  • Help you clearly see how your business earns or spends cash.
  • Provide valuable insight into your company financials.
  • Help you identify trends that can improve your overall business decision-making and make better use of your profits.

What time period your cash flow statement covers is entirely up to you. Some companies prepare cash flow statements annually—covering their full fiscal year—while others prepare them quarterly or even monthly. The frequency you choose should depend on how your business will use the statement and whether more regular reporting will provide a greater benefit.

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What are the 3 different parts of the cash flow statement?

To gain the most value from your cash flow statement, you’ll want to include the following cash flows:

 

1. Operating activities cash flow

This is the money your business generates and spends on daily operating activities: selling products and services, or paying rent and employees.

 

2. Investing activities cash flow

This is the money spent on and generated from market securities, long-term assets, and other financial instruments over the reporting period.

 

3. Financing activities cash flow

Financing activities include the money that moves between a company and its owners, investors, and creditors, such as by issuing equity or debt.

 

You can include an “other activities” section for any type of cash flow that doesn’t neatly fit into these three main activities. Be sure to include line items that break out the various types of cash flow pertaining to that activity, so no cash payments are missed.

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What are the 3 major steps to making a cash flow statement?

Producing the most accurate cash flow statement starts with documenting the company’s inflows and outflows — capital generated, capital lost — generated through three main activities: core operations, investments, and financing. The calculations that need to be made within these three components are:

1. Investments

Investment calculations are only “cash-out” expenses because cash is flowing out from your company in order to purchase/invest in new equipment, assets and other business ventures. This is a particularly crucial component to the cast flow statement because it shows if and where a business is getting a return on their investments — or showing a loss.


2. Financing

This includes any activities such as borrowing from a bank or business financing company.


3. Core Operations

This component shows how much your business makes and/or loses from each individual product and service you offer. It also takes into account any changes in cash involving accounts receivables, depreciation, and inventory. The end total will be your net income.

 

Cash flow from operations can be calculated using either the direct or indirect method.

 

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What is the formula to calculate operating cash flows using the indirect method?

The information needed to prepare the Statement of Cash Flows using the indirect method comes from three sources: two years of comparative balance sheets, the current income statement, and the general ledger.

 

To calculate net cash flow from operating activities using the indirect method, you take the net revenue from the income statement and add back depreciation. You then look at the comparative balance sheet and record the changes in current assets, current liabilities, and other sources (e.g., non-operating gains/losses from non-current assets).

 

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What is the formula to calculate operating cash flows using the direct method?

Using the direct method of cash flow, you count only the money that actually leaves or enters your business during the designated reporting period. You’ll need to review all your cash transactions. This encompasses cash receipts, what you receive in cash; cash payments, what you pay in cash.

 

Cash transactions can include:

  • Cash received from customer sales or payments.
  • Cash paid to suppliers or vendors.
  • Cash payments for operating expenses (like payroll, rent, utilities, etc.).
  • Cash payments for taxes.
  • Cash received from interest, tax refunds, or other activities.

Adding your total cash receipts and subtracting your total cash payments will give you your net cash flow from operating activities.

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What are the differences between the direct and indirect methods?

The indirect method uses net income as the base and performs necessary cashflow adjustments. One of the adjustments is the treatment of non-cash expenses. Depreciation, which is a non-cash expense, is generally added back to the net income followed by additions and deductions arising from the changes in liabilities and assets.

 

The direct method ignores the application of non-cash transactions such as the treatment of the depreciation expense and the impact on the resulting cash flow. Using the direct method, the cash receipt is generally recorded as the receipts from the customers and the cash payments are broadly recorded in terms of payments to the suppliers, employees and payments made to service the taxes, interest expense, and other expenses.

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What makes a good cash flow statement?

The essence of a cash flow statement is that it provides information about an organization’s cash inflows and outflows over a specified time period. A good cash flow statement should accurately:

  • Show how a company raised money (cash) and how it spent those funds during a given period.
  • Test the company’s liquidity because it shows changes over time, rather than absolute dollar amounts at a specific point in time.
  • Gauge the short-term viability of a company.
  • Measure a company’s ability to cover its expenses in the short-term.
  • Reflect the company’s financial health and its ability to pay its bills and other liabilities.
  • Inform the company’s short- and long-term planning.
  • Provide insight into business performance.

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How do you know if cash flow is correct?

There is no guarantee that the cash flow statement you create will be a complete, correct and future-proof representation of what’s going on with your company. A solid strategy to its ensure its accuracy and value is to seek input from a variety of individuals representing multiple departments within the company who can provide you with key figures and unique insights and viewpoints that will help you understand what’s driving the numbers and why.

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What is positive cash flow in a business?

Simply stated, a positive cash flow indicates that a company's liquid assets are increasing. With a positive cash flow, a a business can take care of its obligations, reinvest in its business, return money to shareholders, pay expenses, and provide a buffer against future financial challenges.

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Does positive cash flow always mean profit?

Positive cash flow is not an indication that a business is profitable. It depends on the financial position of the business. A business may be profitable and experience negative cash flow because earning revenue does not always increase cash immediately. So a business can experience more outflow than inflow even when s gross sales are up.

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How do you check if a company is cash flow positive?

Determine the company's earnings before interest, amortization and depreciation.  Add together net income from operations, interest, amortization and depreciation, known as EBITDA. This number represents the cash flow available for paying investors, owners and creditors.

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Is profit more important than cash flow?

The definitive answer is: it depends. A company turning a profit is celebratory news, unless the re is too much cash tied up in receivables or inventory. In this scenario, cash flow is more important than profitability in the short term.

 

The flip side: profitability should be prioritized if a business is unprofitable to the point that it threatens the business’s ability to operate and stay in business.

 

Without a doubt, both profitability and cash flow are important to a business. Yet differing circumstances could dictate one having greater priority over a certain period of time.

 

One statement — many answers

A cash flow statement is a valuable measure of strength, profitability, and the long-term future outlook of a company. Through tracking and analyzing cash inflows and outflows, it informs decision-making. The cash flow statement provides a clear and expansive picture of the company's financial well-being by addressing the business's operational, financial, and investment-related activities.

 

Plooto's digital AP/AR solution with system-wide integration helps you stay ahead of your cash flow. You can time your payments to manage your cash better. You can track invoices and know when your clients pay. In addition, Plooto's accounts receivable invoice automation gives you clear insight into your pending, completed, and new receivables — all from one place.
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CHAPTERS

01    How Do You Manage Cash Flow in Business?

Worrying about managing your cash doesn’t need to keep you up at night. “How Do You Manage Cash Flow in Business?” offers actionable steps to help ensure you have enough cash on hand to meet near- and longer-term obligations, including 22 tips to improve your cash flow.

 

02   Why Are Cash Flow Statements Important for Business?

The cash flow statement informs the company’s short- and long-term planning. But it can do much more -- predict future cash flow, eliminate waste, reduce expenses, provide insight into spending activities, and identify opportunities to create additional cash - as revealed in “Why Are Cash Flow Statements Important for Business?.”

 

03    How Much Cash Flow Should a Business Have?

Knowing how much cash you should have on hand to weather unexpected expenses or business downturns is critical to your business’ success. “How Much Cash Flow Should a Business Have?” covers this and many other crucial topics, including how three simple strategies can help prevent the most common cash flow problems small businesses face.

 

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