The statement of cash flows reports the cash inflows and outflows for your business within a specific time period, and the cash flows are grouped into operating, investing, and financing activities. The statement of cash flows is connected to the balance sheet through your company’s cash account.
This cash flow document is more than simply a report. You can also use the statement of cash flows to make more informed business decisions and improve your company’s financial results.
Bob is the owner of Tailwind Bikes, a bike manufacturer. Here is Tailwind’s statement of cash flows for the period ended March 31st, 2018:
|Tailwind Bikes Statement of Cash Flows for the period ending March 31, 2018|
|Cash received from customers||900,000|
|Cash paid to vendors||-300,000|
|Labor costs paid||-250,000|
|Other operating expenses||-150,000|
|Net Cash From Operating Activities||200,000|
|Purchase of machinery||-50,000|
|Sale of equipment||20,000|
|Net Cash From Investing Activities||-30,000|
|Long-term debt repayments||-75,000|
|Net Cash From Financing Activities||-85,000|
|Net Change in Cash||85,000|
|Beginning Balance in Cash||30,000|
|Ending Balance in Cash||115,000|
You’ll note that the statement groups cash activity into three distinct categories:
- Operating activities: This category includes cash activity related to your day-to-day business operations. Tailwind collects cash from customers, pays vendors and employees, and pays for operating expenses, such as insurance premiums and utility costs. All of these cash transactions are recorded as operating activities.
- Investing activities: The investing activity category addresses cash flows from buying and selling company assets. During March, Tailwind purchased machinery for cash, and also sold a piece of equipment and received cash.
- Financing activities: When Tailwind raises money to operate the business and pays back investors, the cash activity is posted to the financing category. Tailwind paid a dividend to stock investors in March, and also repaid $75,000 on a long-term debt.
Your business will have most of your cash flow activity in the operating section. Investing and financing activities are less frequent, and you may have months with no cash activity in these two categories.
If you visualize your company checkbook, the statement of cash flows accounts for every transaction posted to the checkbook, including all deposits and withdrawals.
The net change in cash is the sum total of all changes in the operating, investing, and financing categories.
In March, for example, Tailwind’s change in cash is a net increase of $85,000. The beginning (March 1st) balance in cash is $30,000, and the ending balance (March 31st) is $30,000 + $85,000 = $115,000.
The $115,000 ending cash balance is also the cash balance listed in the March 31st balance sheet. When an accountant prepares the statement of cash flows, he or she knows that the ending cash balance must equal the balance sheet total. If not, either the balance sheet or the statement of cash flows has an error.
Using the Statement of Cash Flows Report
Here are some important topics that you should consider when you analyze your statement of cash flows:
The vast majority of your business activity should be generated in the operating category because operating activities are repeatable and sustainable. Tailwind, for example, manufacturers and sells bikes, and that activity should generate most of the firm’s cash activity, sales, and profits. The company sold a piece of equipment in March, but that transaction is unusual.
Compare the dollar amount of your operating cash flows to the other two categories. If you notice that a growing percentage of your cash flows are generating through investing and financing transactions, dig into the details and find out why.
Accounts Receivable and Payables
Ideally, your cash inflows from customer payments should be the largest cash inflow item in the cash flow from operations. Most of the operating cash activity will be outflows, including payments to vendors, employees, and for company operations. Also, the net cash flow from operations should be a cash inflow.
If you notice a negative net cash flow in operations, your business is not collecting cash from customers fast enough. You need to assess your cash collections process, and if you need to ask customers to pay a deposit before a sale is completed. These two steps can help you speed up customer payments.
Finally, you should create a formal company budget each year, and the budgeting process should include a cash flow budget for each month. The cash flow budget is your projection of the beginning cash balance, cash inflows, and cash outflows for each month.
Compare your cash flow budget for the month to your actual results in the cash flow statement. This process, known as variance analysis, helps you understand why your actual results differed from your budget. If your actual March sales are higher than budgeted sales, for example, your March cash collections may also be higher.
If you understand the variances, you’ll have a better handle on your business operations, and you can make better decisions moving forward.
Most business owners review the balance sheet and income statement reports, but many owners ignore the statement of cash flows. These owners check their bank balance and reconcile the bank account, but they don’t analyze cash flows in detail.
Even if your accounting software creates the statement of cash flows automatically, you may find the report hard to understand. Ask an accountant for help, if you need it. The statement of cash flows provides valuable information that you can use to make better business decisions.