Do you agree Cash is the king, and then you need to know about the cash flow statement of your business?
Cash is the basis of any business. That’s the reason we say Cash is the King which is a known element. Let’s have a wider look at what is cash flow statement, what is the purpose of creating it, what are the classifications, objectives, advantages, disadvantages, finally what it tells us. To brief it, we will have a complete study of the cash flow statement.
Even a small concern needs enough cash for keeping operating its business activities smoothly. It is a key component of a company’s financial strength and solvency.
What Is a Cash Flow Statement?
A Cash flow statement is one of the three most important financial statements along with a balance sheet and income statement for managing business accounting. It reveals the facts of overall cash management and summarizes the amount of cash and cash equivalents entering and leaving through the business for a specific period. The cash flow statement can also be shown in the budget form to compare with actual figures.
In financial terms, this statement is useful in evaluating the short-term feasibility of a company, particularly its ability to pay its debts obligations.
Monitoring the cash situation whenever necessary is the master key of any business. Normally, Income statement depicts only the profit finally by calculating the money spent and received, it doesn’t show about the net cash available in hand.
To understand in a better way, let see an example of asset depreciation.
Every month we account for depreciation as an expense to arrive at the cost of the asset for its usage. Here we are not actually spending the amount, but for accounting purposes, we take that monthly expenses and reverses it. The cash flow statement only records the cash that we have in reality not in theory for a specified period.
Why do you need cash flow statements?
There are 4 vital reasons why we need the cash flow statement
- Liquidity: Cash flow statement helps to know what exactly we have operating cash flow which is vital for the survival and growth of any organization.
- Change in Performance: It shows the changes in assets, liabilities, and equity in the forms of cash outflows, cash inflows, and cash available in hand. They form the accounting equation that lets you measure your business performance.
- Cash flow projections: It predicts future cash flow by creating projections that help in making long term business plans.
- Loan Process: Cash flow statement plays an important role if we are planning for a secured loan or Overdraft in Bank.
Classification of Cash flow Activities
To ascertain the impact of financial position to show separately how the cash flow is spent & received, such activities are classified into 3 categories
- Operating activities – includes cash activities related to net income
- Investing activities – includes cash activities related to Noncurrent Assets
- Financing activities – includes cash activities related to Noncurrent liabilities and owner’s Equity
Advantages of Cash Flow Statement
- Cash is the origin of all financial operations. Projected cash flow will facilitate the company to plan and control the business activities based on the financial position.
- Along with ratio analysis, cash flow statement helps to measure the success ration of the business
- Helps in knowing the actual liquidity status which is not even provided by profit & loss account and income statement
- With actual liquidity position, any deficits can be arranged in priority or surplus can be used for expansion of the business.
Disadvantages of Cash Flow Statement
- Cash flow statement cannot depict the net income from the operation, so it cannot be an alternative for income statement
- Even Net profit or Net Loss cannot be ascertained with the cash flow statement as it provides only the current cash position of the business. Thus it has only restricted usage.
- The cash flow statement alone cannot decide on the company’s performance. Either it has to accompany with other MIS Reports also.
- The Cash balance shown in the cash flow statement will simply postpone the purchase or other payments since the cash balance is not a valid liquidity position.
Negative cash flow vs. positive cash flow
When a company’s cash flow shows a negative figure at the bottom, it tells you have spent more cash during that accounting period in order to generate income in the subsequent month. Example: Investing in equipment, Advertisement
When a company’s cash flow shows a positive figure at the bottom, it tells you have received more cash during that accounting period maybe you have to pay back in the future. Example: Loans
How to track cash flow using the indirect method
Four simple rules to remember as you create your cash flow statement:
- Transactions that show an increase in assets result in a decrease in cash flow.
- Transactions that show a decrease in assets result in an increase in cash flow.
- Transactions that show an increase in liabilities results in an increase in cash flow.
- Transactions that show a decrease in liabilities result in a decrease in cash flow.
Managing cash consciously supports a company to meet its unpredicted expenses and to handle the monthly fixed costs like Salary, Rent. For a small business managing cash in an effective manner is a very essential skill since they have only less credit facility with their supplier and also have to manage the upfront cost without waiting for the receivables from the customers.
The bottom line of any business is profits, well depicted by the Cash in the company. Where the Balance sheet & Income statement are fiction but cash flow is reality. It is necessary to check the cash flow statement now & then for the smooth running of the business.