A Cash Flow Statement—or a Statement of Cash Flows—is a major financial statement used to track the flow of working capital into and out of a business during an accounting period. While the Income Statement and Balance Sheet are helpful for understanding the financial standing of a company, they do not take into account the complexity of cash flows over time. Cash flow analysis is critical for small businesses, and should be evaluated on a quarterly and monthly basis, if not a weekly or daily.
You begin with the company’s total cash balance at the start of the chosen period, which can be found either at the end of the previous Cash Flow Statement, or (if that’s not available) from the Balance Sheet. Cash flows are then determined by looking at flow of cash within three major categories: operations, investing and finance. Write out the income and payments involved in each of the following categories, and record inflows as a positive number, and outflows as negative.
Operating activities are the main source—and cost—of the company’s cash. These are the direct and indirect costs that are associated with selling a product or service. They include the company’s income from sales (which is calculated in the Income Statement) as well as cash flows that are not normally taken into account in Income Statements. Operational activities include:
- Cash from Continuing Operations: This is essentially the inflow of cash from sales, as well as the outflow of payments to suppliers and company employees. This number can also be taken from the “net income” calculated in the Income Statement.
- Rise or Fall in Accounts Receivable: Accounts receivable refers to money owed to the business by a customer or client for services or goods already delivered. If the amount of accounts receivable has increased, this increase should be subtracted from the total, since it represents money that has not been received—if the accounts receivable has gone down, the amount should beadded.
- Depreciation and Amortization: Next, calculate any decrease in the value of the business’ assets. For example, if a piece of equipment is worth $10,000 and it will function for about ten years, the depreciation value of that equipment will be $1,000 per year (thus recorded as a loss of $1,000 for that period). Depreciation refers to the loss of value in physical assets, while amortization refers to intangible assets such as patents (which expire and will therefore lose their value over time as well).
- Income Taxes Paid: The payment of income taxes is considered an outflow of cash under operating expenses, unless they are directly linked to investing or financing activities.
Investing activities involve buying and selling assets or securities that are not related to the inventory and other operations. This can include long-term assets such as property, equipment, investments, stocks and loan payments that have been given or received by the business. This section will often be in the negative, since it involves the disbursement of cash into various assets and investments.
- Equipment and Property: Any payments made towards the purchase of fixed assets, such as equipment or property, will be marked as an outflow. Any income from the sale of these assets will be counted as an inflow.
- Securities or Investments: Any outflow or inflow of cash due to the purchase or sale of stock or securities by the company should be marked here.
Financing activities include issuing or purchasing stock or equity, borrowing money, repaying debt and handing out dividend payments.
- Proceeds From Long-term Debt: This refers to the cash received or paid out by the business for long-term debt such as bank loans or government bonds.
- Dividends Paid: A small portion of company profits that are issued to stockholders. This should also include payments towards dividend taxes and will be recorded as an outflow of cash.
New Cash Balance
Add up the positive numbers (inflows) and negative numbers (outflows) of cash under operating, investing and finance activities, then add those three values together. Subtract the previous statement’s cash balance from current period to determine the net increase in cash and cash equivalents. To learn more about how to calculate cash flow on a daily, weekly or monthly basis see here.
Cash flow analysis shows that the value of a company at any particular moment may not accurately represent its overall financial health. Many companies can operate successfully with debt and accounts receivable if their growth is based on reliable future earnings. In the same token, a company can be worth a lot in assets but if their ability to maintain and inflow of cash remains unpredictable they have reason for concern.
Cash flow projections and sensitivity analyses are used by businesses in order to evaluate future cash requirements, ensure their ability to pay suppliers and employees on time, secure capital if necessary and avoid a cash flow crisis. A cash flow forecast is considered one of the most critical early warning systems for companies that operate with debt, and should be done on a regular basis.