explorer 23/08/2020 Accounting 0

Statement Of Cash Flow: Everything You Need To Know

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What is the statement of cash flow?

The statement of cash flow is a regular financial statement that tells you all about inflows and outflows of cash. Even it tells you how much cash in hand you have for a specific period.

Statement of cash flow reports the changes in the amount of cash, and cash equivalents held by the entity during the financial period. It measures how well a company performs at cash management, in simple terms, how well a company generates cash to pay its debt obligations and fund its operating activities.

Importance of cash flow for your business

Cash is an integral part of the business and keeping the track of cash flows is much important. Let’s justify it. If you have a car, it needs fuel to run. If you regularly start computing your fuel-efficiency or approach fuel-economy tracking, you can save money on gas and know how to budget for the future. This is how exactly an important management task to monitor the cash flows of your business.

The long-term success of the business depends on positive and sustainable cash flows.

A business must have enough cash to better survive. A business with sufficient cash or having strong liquidity can survive even if it incurs a loss. On the other side, even a profitable business is unlikely to survive if it cannot pay due obligations.

Why do you need a cash flow statement?

As per IAS 7, the statement of cash flow is essential to the users of financial statements for the given reasons.

It is useful when evaluating the entity’s ability to generate cash and cash equivalents.
It provides information about the liquidity and solvency of the business. So when and how quickly an entity can pay its due obligations.
This is useful to investors. It helps them with investment decisions when they see the insights of the company’s cash inflows and outflows.
It helps users of accounts to compare the performance of different entities.
This information lets users determine the entity’s ability to affect the amount and timing of its cash flows in order to respond to changing circumstances and unexpected opportunities.
Historical cash flows are often a fairly reliable indicator. Based on this factor, you can predict the future cash flows of the business. Future cash flow predictions help you in making long-term business plans.

Sections of statement of cash flow

Whenever a business obtains its cash or makes use of it, is recorded in these three sections of the statement of cash flow.

1- Cash flows from operating activities

Cash flow from operating activities is the cash inflows or cash outflows arising in normal trading activities. It is primarily the principal revenue-producing activity of the entity.

A few examples of cash flows from operating activities are:

Cash receipts from the sale of goods and the rendering of services
Cash receipts from royalties, fees, commissions, and other revenue
payments to suppliers for goods and services
Cash payments to employees
Interest payments
Income tax payments
Rent payments

2- Cash flow from investing activities

Cash flow from investing activities is the acquisition and disposal of fixed assets and other investments not included in cash equivalents’. It is generally the money spent on long-term assets the company has purchased or sold.

Cash Inflows arise from the sale of assets, businesses, and investment securities. However, cash outflows are such as capital expenditures for plant, property and equipment, business acquisitions, and the purchase of investment securities.

3- Cash flow from financing activities

Cash flow from financing activities results from changes in the size and composition of the equity capital and borrowings of the entity. It measures the flow of cash among a firm, its owners, and creditors.

A few examples of cash flows arising from financing activities are:

cash received from issuing shares or other equity instruments
Payments in cash to owners to acquire or redeem the entity’s shares
cash received from issuing debentures, loans, notes, bonds, mortgages, and other short-term or long-term borrowings
cash repayments of amounts borrowed.

The separate disclosure of cash flows arising from financing activities is important as it is useful to predict claims on future cash flows by providers of capital to the entity.

Statement of cash flow with direct and indirect method

There are two methods to present a statement of cash flows, the direct method, and the indirect method.

We calculate cash flows from investing activities and financing activities, in the same way, using both methods. The difference between the two methods is only relating to operating activities.

1- Direct method to calculate cash flow

When you use this method, you keep a record of every cash transaction either you receive or make any payment.

Using the direct method, you need to reconcile net income with cash from operating activities.

2- Indirect method to calculate cash flow

The indirect method identifies the cash flows from operating activities by adjusting the profit before tax figure. We calculate cash from operating activities figure indirectly by reconciling a profit figure to a cash figure.

As it is easier than the direct method, many small businesses prefer this approach.

Positive cash flows vs Negative cash flows

The cash flows for each category might be positive or negative. When a cash flow statement displays positive figures at the bottom, it means you have positive cash flows. A business with positive cash flow is somehow in a sound liquidity position, but it is not necessarily a good thing in the long run. For instance, you acquire a huge loan to source your failing business. In a nutshell, Positive cash flow doesn’t mean positive overall.

Negative cash flow arises when a business spends more cash than it makes during a specific period. If your cash flow isn’t positive, that doesn’t always mean that your business is at the red alert. There could be several reasons your cash flow may be temporarily down.

Template for a statement of cash flow

IAS 7 specifies the content and format of a statement of cash flow. It does not specify what the exact format of a statement of cash flow should be, but it provides suggested layouts in an appendix.

All cash flows can be included in one of these three categories we discussed earlier. The sum of cash flows for all three categories together explains the overall increase or decrease in cash and cash equivalents.