Written By- Shavalik Mehra
Reviewed By- Himanshu Kumar
There are a lot of transactions that take place in a business every single day. Some transactions involve debit of cash while others involve cash credit. These transactions have various purposes including sales of goods, purchase of goods, payment of salaries and wages, purchase of assets, etc. The net outcome is significant for business owners and other stakeholders. To calculate the net result, a cash flow statement is used. In this article, we will understand what is cash flow statement, its format, its components, and its significance in any business.
What is a Cash Flow Statement?
A cash flow statement records all debit and credit transactions that are settled in cash in any particular business. It is one of the most useful financial statements that is used in any business. The cash flow statement provides insights on various key points including the cash position of any business, the amount it owes from debtors, its operating expenses, etc. The cash flow statement is used with the Income Statement and Balance Sheet to know the financial position of any business. Let’s understand the components of the cash flow statement.
Components of Cash Flow Statement
A cash flow statement includes three major components including:
Cash From Operating Activities
A business earns revenue either by selling products or services to its customers. The cash flow from operating activities includes the cash revenue generated by a business from selling its products or services.
The cash flow from operating activities includes:
- Cash received from the sale of goods and services.
- Cash paid to suppliers for goods and services.
- Wages and salaries paid to the employees.
- Rent paid.
- Interest payments.
- Any other operating income or expense.
* A company whose major business is providing loans, equities or debt also includes these receipts in cash flow from operating activities.
Cash From Investing Activities
A business invests money in some assets and also takes loans for various purposes including expansion, operations, etc. The cash flow from investing activities includes any change that occurs in cash due to investment activities such as the purchase or sale of assets or securities, interest received, interest paid, etc.
The cash flow from investing activities includes:
- Purchase of business assets.
- Investment made by the business in stocks or other financial securities.
- Sale of assets.
- Sale of investments.
- Collection from provided loans.
- Sale of investments.
Cash From Financing Activities
The cash flow from investing activities includes dividend payments, loan repayments, issue of bonus shares. It usually includes all activities that take place between businesses, investors, and banks.
Cash flow from financing activities includes:
- Issue of shares.
- Dividend payments.
- Issue of loans.
- Repayment of loans.
- Any other finance-related payment.
Cash Flow Statement Format
Here is the cash flow statement format you can use.
The above example is a cash flow statement of XYZ company for the year 2023. It highlights the cash involved in operating, investing, and financing activities. It shows you how to read a cash flow statement. The cash receipt value is written as it is in the cash flow statement while the cash paid value is written in brackets to identify positive and negative values easily. Firstly we calculate cash flow from operating, financing, and investing activities one by one. Then all these values are used to calculate the net cash flow of a company for a particular year. A positive cash flow is a good sign for any business. It shows that the company has enough cash to meet its financial obligations.
How to Prepare a Cash Flow Statement?
Creating a cash flow statement does not involve any hard and fast rules. You can create the cash flow of your business by just following some simple steps defined below.
1. Collect your financial records of cash inflow or outflow
You have to collect all the receipts and payment records that are incurred in cash.
Cash Receipts- Received from the sale of goods, income from investments, cash received from the sale of assets, cash received from issued loans, etc.
Cash Payments- Purchase of inventory, Operating expenses, Amount paid to acquire assets, Repayment of loans, etc.
2. Choose the period for which cash flow is generated
You have to mention the period for which you are preparing the cash flow statement. You can make cash flow statements monthly, quarterly, half-yearly, or yearly.
3. Make the cash flow statement
Make the cash flow statement by dividing receipts and payments into specific categories of operating, investing, and financing activities. Subtract cash outflows from the inflows in each component.
4. Make a combination of all components
You have to calculate a net amount by combining the amount from operating, investing, and financing activities. A positive amount stands for positive cash flow while a negative figure stands for negative cash flow.
5. Add the net cash flow with the opening cash balance
You have to add the net change in cash from all three activities with the opening cash balance to arrive at the final amount. Make sure that this amount matches the cash amount in your balance sheet.
Significance of Cash Flow Statements
A cash flow statement is a significant financial statement for any business. Let’s understand the importance of a cash flow statement for a business.
1. Helps to make major financial decisions
A cash flow statement helps business owners and other stakeholders to make major financial decisions for their businesses such as expansion, purchase of assets, making investments, etc. A business having a positive cash flow statement can use its surplus cash for business growth.
2. Provides insights into the company’s cashflows
By looking at the company’s cash flow statement the stakeholders can get various insights that they require. It provides insights including major cash expenses of the company, cash receipts, and which activities are using most of the cash.
3. Helps to understand sector-wise cashflow
The cash flow statement of a business is divided into three activities- operating, financing, and investing activities. This statement helps the stakeholders to understand the sector-wise cash flow of a business.
4. Focus on possible actions to improve cashflow
If a business is using excess cash on some of its activities that won’t generate lucrative outcomes, you can check the same in the cash flow statement. You can take appropriate measures to improve the cash flow by making appropriate decisions.
5. Improves business transparency
A cash flow statement improves business transparency as business stakeholders can use it to make important decisions based on it. All stakeholders must have access to the business cash flow.
Conclusion
A cash flow statement is an important financial document made by any business to analyze the inflow and outflow of their cash. It is right to say that a cash flow statement is important to assess the financial condition of a business but to get a clear picture you must check your income statement and balance sheet of a company. Sometimes looking at a negative cash flow people assume that this company is not financially stable. But that is not the case. Usually, businesses invest their cash in expansion or other growth activities leading to a negative cash flow.
FAQs: What is a Cash Flow Statement
There are three components of a cash flow statement including cash flow from operating, investing, and financing activities.
To prepare a cash flow statement you have to collect your cash receipt showing inflows and outflows. Arrange all these inflows and outflows in the operating, investing, and financing components. Calculate the net cash flow and add it to the opening cash balance to obtain the closing cash balance.
A cash flow statement is important for businesses for various reasons including better decision-making, business transparency, taking possible actions if required, and getting insights for component-wise activities.
A cash flow statement is an important financial statement that shows a business’s financial position, solvency, liquidity, business’s health, etc.
