ArtsAutosBooksBusinessEducationEntertainmentFamilyFashionFoodGamesGenderHealthHolidaysHomeHubPagesPersonal FinancePetsPoliticsReligionSportsTechnologyTravel
  • »
  • Business and Employment»
  • Business Management & Leadership

What Is a Cash Flow Statement and Why Should You Prepare One?

Updated on January 21, 2018
Track your cash flow
Track your cash flow

What is a cash flow statement?

A cash flow statement is essentially a statement which captures the movement of cash in your business during a specified period for which it is prepared. Generally, it is prepared at the end of the year along with other financials, but it could be prepared at quarterly or monthly intervals. A cash flow statement is a snapshot of all the cash transactions that take place during the year. It does not report non cash transactions unlike the income and expenditure account or the profit and loss account. As a result, it forms an important decision making tool for managers and business owners. The health of a business can be gauged from this statement. In fact, continuous cash losses are an indicator of business or industrial sickness. A business can survive normal losses but cash losses often spell doom.

Profits arrived as per the accrual basis of accounting do not represent cash profits. This is because a profit and loss account records income earned and expenditure incurred and not income received and payments made in cash. So just because your profit earned for the year is $10,000 doesn't mean that you have $10,000 in cash from business, unless you only sell for cash and settle all expenses before the end of the year in cash. This is because sales consist of both cash sales and credit sales. Cash sales are sales for which cash is received immediately and the sale is concluded. However, in credit sales, the sale is recorded now but the cash is received at a future date. Maybe even next year or accounting period. A cash flow statement would capture only the cash sale.

Choice of Method

There are basically two ways in which cash flow statements are prepared:

  • The Direct Method
  • The Indirect Method

Both the methods give the same result. However, the manner and complexity of preparation varies. It would be more suitable for small businesses to follow the Direct Method owing to its simplicity. The Indirect Method is more complicated of the two and requires more time and details. The indirect method is usually prescribed for reporting requirements in many countries, especially for big business entities.

Direct Method

The direct method is the simplest and the most straightforward of the two. It comprises of the following components:

Cash flow from operating activities:

Essentially it captures sales made in cash during a period less all operating expenses paid in cash. Operating expenses include all expenses incurred to produce the product or service and exclude all expenses of Finance and Investment. Taxes paid on operating income are included here. The computation is as follows

  1. Cash sales
  2. Less cash operating expenses
  3. Less/Add net increase or net decrease in working capital changes.(This adjustment should be done only when cash sales figure is not available and total sales which includes credit sales also is taken)
  4. Less taxes on operating income

Cash flow from Investing Activities:

These are cash transactions involving the purchase and sale of property plant and equipment. Any taxes paid in relation to such sale or purchase are shown here. The sub total may be positive or negative. Excess purchase over sale shows negative balance and this indicates the business is in expansion mode. Excess sale is an indicator of disposal of property plant and equipment which is not a good sign.

Cash flow from Financing Activities:

These are transactions showing payment or receipt of loans, interest, dividend. Receipt of new share issues, bonds, all types of loans except loans for Investing Activities and the redemption of shares or bonds are also included. All taxes relating to Financing activities like transaction tax and dividend tax fall under this part. The sub total may be positive or negative. Positive means there is an influx of capital into the business and negative means repayments or redemption of debts. This part captures capital movement in cash.

Indirect Method

Indirect method is the same in structure as the direct method except in the case of cash flow from operating activities. The cash flow from operating activities is arrived at from the net profit or loss as indicated by the profit and loss statement in the financials. The computation is as follows:

  1. Net profit or loss as per the profit and loss statement
  2. Add back all non operating expenses (Finance and Investment expenses)
  3. Add back all non cash expenses
  4. Deduct all non operating income (Finance and Investment income or gains)
  5. Deduct all non cash income (Accrued income)
  6. Deduct net increase in working capital change or Add net decrease in working capital case respectively as the case may be.

Cash flow from the Investing and Finance income part is the same as in Direct Method.

It is essential to prepare a cash flow statement in order to track the flow of cash and funds in your business. Cash flow statements are invaluable because banks and financial institutions evaluate loan and credit proposals on the basis of cash flow statements

Perform cash analysis

Movement of cash
Movement of cash

Necessity for a cash flow statement

Cash flow statement is critical and invaluable for your business for the following reasons.

  1. It is essential to prepare a cash flow statement in order to track the flow of cash and funds in your business.
  2. Cash flow statements are invaluable because banks and financial institutions evaluate loan and credit proposals on the basis of cash flow statements.
  3. Cash flow statements are an important tool for business and performance analysis.
  4. Cash flow statement is an important tool for identification of inefficient cash management and to prevent leakage of cash.
  5. A good cash flow statement reflects the value of a business.

Prepare a cash flow statement today and take control of your business.

Comments

    0 of 8192 characters used
    Post Comment

    No comments yet.

    working

    This website uses cookies

    As a user in the EEA, your approval is needed on a few things. To provide a better website experience, hubpages.com uses cookies (and other similar technologies) and may collect, process, and share personal data. Please choose which areas of our service you consent to our doing so.

    For more information on managing or withdrawing consents and how we handle data, visit our Privacy Policy at: "https://hubpages.com/privacy-policy#gdpr"

    Show Details
    Necessary
    HubPages Device IDThis is used to identify particular browsers or devices when the access the service, and is used for security reasons.
    LoginThis is necessary to sign in to the HubPages Service.
    Google RecaptchaThis is used to prevent bots and spam. (Privacy Policy)
    AkismetThis is used to detect comment spam. (Privacy Policy)
    HubPages Google AnalyticsThis is used to provide data on traffic to our website, all personally identifyable data is anonymized. (Privacy Policy)
    HubPages Traffic PixelThis is used to collect data on traffic to articles and other pages on our site. Unless you are signed in to a HubPages account, all personally identifiable information is anonymized.
    Amazon Web ServicesThis is used to collect data on traffic to articles and other pages on our site. Unless you are signed in to a HubPages account, all personally identifiable information is anonymized. (Privacy Policy)
    CloudflareThis is used to quickly and efficiently deliver files such as javascript, cascading style sheets, images, and videos. (Privacy Policy)
    Google Hosted LibrariesJavascript software libraries such as jQuery are loaded at endpoints on the googleapis.com or gstatic.com domains, for performance and efficiency reasons. (Privacy Policy)
    Facebook LoginYou can use this to streamline signing up for, or signing in to your Hubpages account. No data is shared with Facebook unless you engage with this feature. (Privacy Policy)
    PaypalThis is used for a registered author who enrolls in the HubPages Earnings program and requests to be paid via PayPal. No data is shared with Paypal unless you engage with this feature. (Privacy Policy)
    Google AdSense Host APIThis service allows you to sign up for or associate a Google AdSense account with HubPages, so that you can earn money from ads on your articles. No data is shared unless you engage with this feature. (Privacy Policy)
    Features
    Google Custom SearchThis is feature allows you to search the site. (Privacy Policy)
    Google MapsSome articles have Google Maps embedded in them. (Privacy Policy)
    Google ChartsThis is used to display charts and graphs on articles and the author center. (Privacy Policy)
    Google YouTubeSome articles have YouTube videos embedded in them. (Privacy Policy)
    VimeoSome articles have Vimeo videos embedded in them. (Privacy Policy)
    MavenThis supports the Maven widget and search functionality. (Privacy Policy)
    Marketing
    Google AdSenseThis is an ad network. (Privacy Policy)
    Google DoubleClickGoogle provides ad serving technology and runs an ad network. (Privacy Policy)
    Index ExchangeThis is an ad network. (Privacy Policy)
    SovrnThis is an ad network. (Privacy Policy)
    Facebook AdsThis is an ad network. (Privacy Policy)
    Amazon Unified Ad MarketplaceThis is an ad network. (Privacy Policy)
    AppNexusThis is an ad network. (Privacy Policy)
    OpenxThis is an ad network. (Privacy Policy)
    Rubicon ProjectThis is an ad network. (Privacy Policy)
    TripleLiftThis is an ad network. (Privacy Policy)
    Say MediaWe partner with Say Media to deliver ad campaigns on our sites. (Privacy Policy)
    Remarketing PixelsWe may use remarketing pixels from advertising networks such as Google AdWords, Bing Ads, and Facebook in order to advertise the HubPages Service to people that have visited our sites.
    Conversion Tracking PixelsWe may use conversion tracking pixels from advertising networks such as Google AdWords, Bing Ads, and Facebook in order to identify when an advertisements has successfully resulted in the desired action, such as signing up for the HubPages Service or publishing an article on the HubPages Service.
    Statistics
    Author Google AnalyticsThis is used to provide traffic data and reports to the authors of articles on the HubPages Service. (Privacy Policy)
    ComscoreComScore is a media measurement and analytics company providing marketing data and analytics to enterprises, media and advertising agencies, and publishers. Non-consent will result in ComScore only processing obfuscated personal data. (Privacy Policy)
    Amazon Tracking PixelSome articles display amazon products as part of the Amazon Affiliate program, this pixel provides traffic statistics for those products (Privacy Policy)