A Statement of Cash Flows is one of four basic documents used for financial reporting. The others are the Balance Sheet, which represents the company’s financial condition at a specific point in time, the Income Statement, which presents the results of operations, i.e. profit or loss, for a specific period of time, and the Statement of Owners’ Equity, which details the changes in the value of the owners’ stake in the company. In accrual accounting, these other documents are based on when transactions took place, rather than when cash changed hands. The Statement of Cash Flows provides the data on what happened from a cash perspective.
Cash is either brought into the company or used by three different activities – daily operations, investing, and financing. The Statement of Cash Flows details how each activity affected the company during the relevant period. The report summarizes the net change in cash for the period in question, either an increase or a decrease.
Cash flow is important because a business must be able to pay its regular expenses, and if the company is not bringing in enough cash or is using too much cash or using it ineffectively, the company may find itself unable to meet payroll or pay its other obligations.
Cash goes in and out of a company daily through normal business transactions. When a customer pays an invoice, cash is received and the account receivable is reduced. When the company pays a vendor, cash leaves the business and the account payable is reduced. These types of transactions are detailed as part of operations.
Investing activities usually involve the purchase of land and buildings or equipment, but can also involve the purchase or sale of securities. In order to grow, businesses often need to upgrade machinery or establish new facilities to accommodate expansion. These activities use cash.
Financing activities involve receiving cash from new loans or from selling stock. Financing can also reflect a use of cash when paying off a loan.
One of the basic things that accountants look at is whether the cash produced by operations is consistent with net income. If the cash inflow from operations is consistent with net income, the company is managing its receivables and payables well. If the company has good sales numbers but is not collecting its accounts receivable in a timely fashion, the result is a lower inflow of cash than the net income.
To look at it another way, if your customers are taking ninety days to pay you, but you are paying your vendors in thirty days, you’re eventually going to have a cash problem because your outflow is sixty days ahead of your inflow. The cash flow statement can highlight this kind of problem.
Absent any significant expenditures for new property or equipment, if your business is profitable, your cash should gradually increase over time. This increase in cash can be used to pay down debt, expand the business, or pay a dividend to shareholders.
Good business managers look at their cash flow as carefully as they look at the income statement. Making a profit is a good thing, but if the cash flow is not under control, those profits can quickly disappear.