The cash flow statement documents the cash and cash equivalent assets of a business. It demonstrates how a company not only manages its cash, but also how it generates cash.
What Is a Cash Flow Statement?
A cash flow statement lists a company’s cash and cash equivalent assets. This shows how much cash the company has at a given time plus how well the company generates cash. Cash flow in accounting can provide a snapshot of how a company is performing. This provides crucial insight for lenders who may be underwriting a loan for the company. In addition, it provides a picture of the company for stockholders and investors who want to see how financially successful and secure the company is.
Understanding the Practical Applications of a Cash Flow Statement
The purpose of a cash flow statement is to showcase several aspects of a company’s day-to-day operations. For instance, it provides insight into how a company spends its funds, and can help determine budgeting to meet short-term goals. In addition, it can not only provide how effective the company’s cash planning initiatives are, but also show areas where the company can increase cash flow.
As with short-term goals, a cash flow statement also can help a company plan out its strategies for achieving its long-term goals. And, when a company has a clear idea of its cash flow, it can spotlight potential weak spots that could lead to a cash flow shortage, allowing the company to avert such a situation in advance.
Structure of the Cash Flow Statement
A cash flow statement contains three activities related to how the business uses cash. These are:
Cash Flow From Operating Activities
Operating activities refer to operating costs such as providing services or selling and buying merchandise. These include inventory, accounts payable and receivable, wages, taxes, rent, and other operating expenses.
Cash Flow From Investing Activities
Investing activities refer to the company’s purchase or sale of real estate and property such as vehicles, equipment, furniture, and other items. These items are considered assets of the company.
Cash Flow From Financing Activities
Financing activities refer to a company’s cash transactions related to stock purchases and sales, retained earnings and dividend payments, and other debt financing.
Disclosure of Non-Cash Activities, Which is Sometimes Included When Prepared Under Generally Accepted Accounting Principles (GAAP)
Public companies must prepare their cash flow statements using the generally accepted accounting principles (GAAP) as issued by the Financial Accounting Standards Board (FASB). As such they may need to disclose non-cash activities that affect the company’s performance as it relates to revenue, profits, and the company’s ability to generate cash flow. Examples of this include converting debt to common stock, exchanging non-cash assets, and issuing stock to retire debt.
How is Cash Flow Calculated
Two common methods are used to calculate and prepare the operating activities section of cash flow statements.
Direct Cash Flow Method
The direct cash flow method lists all cash paid out and cash received in. This includes cash paid out for salaries, rent and supplies, as well as cash receipts received from customers.
Indirect Cash Flow Method
The indirect cash flow looks at cash flow from non-cash transactions. For instance, this would refer to the depreciation of vehicles, computers, or other equipment. It also applies to amortization–or spreading payments over a specific period of time–of loans or other payments.
Limitations of the Cash Flow Statement
While a it shows a picture of the company’s ability to manage and generate its cash on hand, it’s not always an accurate statement of how successful the company is. For instance, a cash flow statement could show a negative cash flow, but it could occur during a company expansion, which could be part of the company’s long-term goals. It’s important to know how to read a statement of cash flows and examine the reasons for a negative cash flow before assuming it means the company is failing and headed to bankruptcy.
Cash Flow Statement vs. Income Statement vs. Balance Sheet
A statement of cash flow showcases how a company is performing and may include elements from an income statement and a balance sheet. Also called a profit and loss statement, an income statement incorporates revenue, expenses, gains, and losses of the company for a specific period. This spotlights such company aspects as management efficiency, how specific sectors are performing, and how the company is performing relative to its peers.
A balance sheet documents the company’s assets, liabilities, and shareholder equity for a specific time period. It serves to show what a company owns as well as the company’s debts, along with how much shareholders have invested.
Frequently Asked Questions
What does a cash flow statement mean?
A cash flow statement contains a detailed list of a company’s cash and cash equivalent assets. A cash flow statement analysis shows how much cash the company has plus how well the company can generate cash.
