If you are wondering how businesses monitor and analyze their performance, a cash flow statement is required to maintain any company’s financial health. Understanding the basics of the cash flow statement is crucial, as it is a financial report that provides you with the movement of cash in all the departments of your company. This knowledge empowers you to make professional financial decisions, making it an indispensable tool in your business arsenal.
Understanding Cash Flow Statement:
It is a report that is based on the finances of any company. This report shows the cash movement in and out of your business company over a specific period. This report provides a complete description of the money entering and leaving your organization, unlike the other income statements, which only focus on the profit.
It is also as important as the balance sheet and the income statement. So, the CF Statement plays a vital role in evaluating any business’s liquidity and financial stability.
Components of Cash Flow Statement
Some components are mainly included in the cash flow statement. These include:
- Operating Activities:
This section comprises the cash generated in day-to-day business operations. Moreover, this financial report’s operating activities include payments sent to suppliers, money received from sales, salaries, and utility payments.
If this section provides you with positive feedback, then your business is running very smoothly. But if it allows for a negative number, it shows that your business is not sustainable for long-term growth.
- Investing Activities:
In this section, the cash spent on long-term investments is calculated and monitored. It includes the overall performance and monitoring of the company’s assets and what people are investing in. This consists of investing in real estate, purchasing equipment, and selling and buying shares in other companies.
If the CF Statement is negative, it won’t benefit the company. However, if the cash flow is positive, the company invests positively with profitable growth.
- Financing Activities:
This section comprises the cash moving between the company and the investors. This includes purchasing and issuing stocks, repaying loans, making dividend payments, etc. If the cash flow statement based on the financing activities shows positive results, then it indicates that the company is working very efficiently. However, negative cash flow shows there is still debt repayment or no purchasing left for the stocks.
Methods of Preparing a Cash Flow Statement:
There are two primary methods, the direct and indirect methods, which help prepare the CF Statement. These methods are used to prepare this statement based on the operating activities. Following is the detail of both the methods:
- Direct Method:
This method includes listing all the cash payments during the reporting time. It is a very straight process and easy to understand. However, this process is not commonly used in companies to generate a CF statement.
For example, a CF Statement helps segregate the cash received from clients and the money paid to employees.
- Indirect Method:
The indirect method of making a cash flow statement starts with net income and usually includes non-cash items. This method is most commonly used for preparing CF Statements because it directly involves the details of the income statement, which includes the company’s net income.
It does not matter which method is used to prepare the CF Statement. The cash flow is completely determined, and the net flow remains the same. So, any method can be used to generate a cash flow statement, mostly for various businesses.
Why Cash Flow Statement is Important?
If you are searching for why the CF statement is important for any business, then the following are some of the reasons regarding this:
- Evaluate Liquidity:
The CF Statement is a powerful tool for evaluating a business’s liquidity. It determines whether the company can pay all utility bills on time. Positive cash flow indicates a smooth-running company, while negative cash flow is a warning sign of potential financial distress, urging caution and vigilantism.
- Assess Financial Flexibility:
The cash flow statement is also a key player in assessing the financial stability of any company. It provides you with complete details on whether the operations in the company are generating enough cash for the growth of your business. This reassurance can instill confidence in your business decisions.
- Help in Loan Approval:
The CF Statement is also very helpful when your company decides to get a loan from lenders. The lenders overview the cash flow comprising your company’s previous performance. Then, they grant you credit according to the CF Statement results.
- Highlight Main Problems:
This statement is also very helpful in highlighting the main problems, like the company’s cash shortage. It provides an indication of any problem before it occurs, which is very helpful for any business. As a result, this CF statement is very helpful for a business’s overall finances.
FAQs
1. What is the central role of a cash flow statement?
Ans. The primary role of a cash flow statement is to provide the company’s inflow and outflow details. It helps the stakeholders in evaluating the complete performance of the company.
2. How is a cash flow statement different from an income statement?
Ans. The income statement provides details regarding the profitability of non-cash items only, while the cash flow statement focuses on the actual cash movements.
3. Which method is better for generating a cash flow statement?
Ans. The direct method is easy to understand. However, the indirect method is the most commonly used because it works closely with the income statement.
Wrapping Up
Now, after understanding the cash flow statement and why it is essential for any company, you can easily start your business and evaluate its performance. This statement is beneficial in determining the financial strength of any company. Moreover, it is also helpful for business owners, investors, and other economic analysts. So, as a result, it provides complete details of where your money is going and how much profit it is making.