Cash flow statement

Current assets are used to pay off short-term or current liabilities, such as accounts payable and the portion of long-term debt that’s due. Liquidity is defined as either having immediate cash or maintaining assets that can be converted into cash in a short period of time. Enough liquidity can help pay for liabilities and debt. If you’ve never created a cash flow statement, you can pull your numbers from your ledger or accounting records.

Cash flows from operating activities is the first section of the cash flow statement and is called “the cost of doing business.” This section includes any sources and uses of cash to conduct business operations. Examples include cash receipts from goods sold, payments to employees, taxes, and payments to suppliers

The indirect method of preparing a cash flow statement begins with your net income number, which is a measure of your profitability. This number is pulled from your income statement. Following net income, cash and non-cash items are reconciled from your business activities. Examples include cash receipts from customers, cash paid out to vendors, labor costs, and other operating expenses. The indirect method is widely used because the information is the easiest to gather. The indirect method reconciles net income to cash flow from your operations.

If you’re using a cash flow statement that uses the indirect method, you’ll need to categorize each of your costs as positive (incoming) or negative (outgoing) cash flow to accurately reflect those types of transactions. Here’s a breakdown of what’s included in the operating activities category:

•  Cash from continuing operations: This is the inflow of cash from sales, as well as the outflow of payments to vendors (i.e. suppliers) and company employees.
• Increase or decrease in accounts receivable: Accounts receivable refers to money owed to your business by customers or clients for services or goods already delivered. If the amount of accounts receivable has increased, then it should be subtracted from your total since it represents money that hasn’t been received. If the accounts receivable has decreased, the amount should be added to your total.
• Depreciation and amortization: Next, calculate any decrease in the value of your business assets. For example, if a piece of equipment is worth $10,000 and its life expectancy is about 10 years, the depreciation value of that equipment will be $1,000 per year (and recorded as a $1,000 loss for that period). It’s important to note that depreciation and amortization expenses are non-cash expenses. They occur when an asset is used to operate the business, which results in that asset losing value over time. Depreciation refers to physical assets, while amortization refers to intangible assets such as patents, which expire and lose value over time.
• Income taxes paid. This is considered an outflow of cash under operating expenses.

Here are some common line items found under the operating activities section:

• Accounts receivable (A/R): The amount your business is owed by customers for goods and services that they purchased on credit.
• Accounts payable (A/P): The amount you owe creditors for purchasing goods and other operational equipment.
• Depreciation: A non-cash expense that results from an asset — like a computer or a vehicle — losing value over time as it’s used for business operations.
• Inventories: The dollar amount of goods available for sale to generate income for your business.
• Net cash balance: The total amount of cash deposited, minus any cash disbursements.
• Net income: The amount remaining after you subtract all your business costs from your total revenue. This is your profit.

Adding net income, accounts receivable, accounts payable, depreciation, amortization, inventories, and income taxes paid will give you the net cash flows from your operating activities.

Cash flows from investing activities is the second section in a cash flow statement. It involves long-term uses of cash, such as a purchase (cash outflow) or sale (cash inflow) of a fixed asset (like property or equipment).

Small business investments are usually centered around cash spent on property (like purchasing real estate for employees), factories (this can be a mechanical or an industrial factory, depending on the nature of your business), and equipment intended to grow business operations or perform them in a more efficient manner.

It’s important to note that this section of your cash flow statement will normally be in the negative. That’s because you’re acquiring assets in the first place. Purchasing fixed assets is considered pure cash outflow.

Here’s a further breakdown of what’s included in your investing activities section:

• Capital expenditures: Money that’s spent to acquire, improve, or maintain any physical assets such as property, buildings, technology, or equipment.
• Acquisitions: Any funds used to pay for the acquisition of new, long-term investments.
• Proceeds from asset sales: When you sell long-term assets, the amount you receive is referred to as the proceeds. If the proceeds from the assets sold are greater than the original (or book) value of the asset, it’s considered a net gain (cash inflow). If the proceeds are less than the book value at the time of sale, it’s a net loss (cash outflow).

For instance, if you purchased machinery that cost $25,000, it will be considered an outflow. If your equipment was sold for $20,000, it’s considered an inflow. Adding these 2 will give you the net cash flows from investing activities, giving you a total outflow of $5,000,which is displayed as a negative in your cash flow statement).

Cash flow from financing activities is the third category of a cash flow statement. It includes inflows of cash from investors and banks, and outflows of cash to shareholders, which are referred to as dividend payments.

Companies seek financing by either taking on debt such as a loan from a bank, or issuing equity to investors in exchange for their cash. Over time, companies have to pay back those loans, or pay dividends periodically to their investors for infusing cash into the business.

Here are some types of financing activities that your business could have:

• Proceeds and cash payments related to long-term debt: This refers to the cash received or paid out by your business for long-term debt such as bank loans or government bonds. Cash payments and cash receipts pay principal debt balances, and are included in the financing activities category. Any interest payments, on the other hand, are reported in the cash flows from operating activities section.
• Short-term notes payable: This type of debt must be paid off in a short amount of time, usually in less than a year.
• Dividends paid: This is a small portion of company profits that are issued to stockholders (individuals or institutions who have invested in your business). This includes payments toward dividend taxes, which should be recorded as an outflow of cash.
• Other current liabilities: A grouping of debts that aren’t covered under common liabilities, such as accounts payable.

In the beginning, business owners and entrepreneurs look for funding to help get their businesses up and running. If they’re successful and capital comes in, there’s a cash inflow. When dividends are paid to those investors, there’s a cash outflow.

Adding up the proceeds from long-term debt, notes payable, dividends paid out, and other current liabilities will give you the net cash flows from financing activities.

You’ll have a new cash balance when you add the net cash flows from operating, investing, and financing activities.

Here’s your cash flow statement summarized in a formula:

The total will be the new cash balance at the end of the fiscal or calendar year. When you take the new cash balance and add it to the cash balance from the end of the last period (or the last year), you’ll get the net increase (or decrease) in cash and cash equivalents for the time frame you selected. These numbers can be used at the beginning of the next period to do your calculations for the next cycle.

You can use cash flow statements to project your future cash flows. Forecasting with these numbers gives you an idea of how your company is operating, and if there’s any cause for concern in the near future.

For example, a company may be valuable for its assets and investments, but a spotty inflow line item can be concerning. Conversely, many companies can operate successfully with debt and accounts receivable if their growth is based on reliable future earnings.

Now that we talked about the standard essential elements and methods of a cash flow statement, you can easily analyze the information to forecast your future cash flows.