Cash flow statements are one of the most important, yet often overlooked, financial documents for any business. As a business owner or manager, understanding your company’s cash flow can provide invaluable insights into the financial health and viability of your operations. In this article, I’ll explain what cash flow statements are, why they matter so much, and how you can use them to make smarter business decisions.
What Is a Cash Flow Statement?
A cash flow statement records the actual flow of cash into and out of a business over a specific time period. It breaks down cash inflows and outflows into three main categories:
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Operating activities – This includes cash generated through day-to-day business operations. For example, cash received from customers and cash paid to suppliers and employees
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Investing activities – Cash flows related to investments, such as purchasing or selling assets like property, equipment, securities, etc.
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Financing activities – Cash flows from financing the business including taking on debt equity financing, dividend payments, etc.
The cash flow statement paints a detailed picture of the sources and uses of a company’s cash during the reporting period. This provides crucial insights that the income statement and balance sheet don’t show.
Why Cash Flow Statements Matter
Here are some key reasons why cash flow statements are so important:
1. Shows Liquidity
The cash flow statement highlights the company’s liquidity and ability to generate cash to fund current operations and future growth. Even profitable companies can face severe liquidity issues if they are not efficiently converting profit into cash. Analyzing the cash flow statement can prevent nasty surprises.
2. Assesses Financial Health
The cash flow statement provides a better assessment of financial health than the income statement or balance sheet alone. Positive cash flow enables a company to settle debts, reinvest, and provide returns to shareholders. Negative cash flow over extended periods can signal financial troubles ahead.
3. Helps Manage Cash Position
Regularly monitoring the cash flow statement helps managers understand expected cash inflows and outflows. This makes it easier to manage cash balances, short-term borrowing needs, and optimization of cash through mechanisms like just-in-time inventory.
4. Determines Sustainability
The cash flow statement determines whether the company can sustain its current operating requirements and growth plans. Consistently negative cash flows will rapidly erode the business. Analyzing cash flow trends can highlight potential red flags.
5. Evaluates Management Decisions
Cash flow analysis evaluates the outcome of key management decisions such as capital expenditures, acquisitions, dividend payouts, etc. Poor decisions will show up as distortions in cash flow that require corrective action.
6. Provides Realistic View
Accrual accounting can present an overly optimistic view of the company’s performance. The cash flow statement provides a reality check by exposing how much cash the company is actually generating regardless of paper profits.
How to Analyze a Cash Flow Statement
Now let’s look at how you can analyze the cash flow statement to glean insights about your business:
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Check cash from operations – This is the cash generated from regular business activities. Is it positive and consistent? Is it sufficient to cover capital expenditures?
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Evaluate cash flow margins – Divide cash from operations by revenue to determine the percentage of cash derived from revenue. Compare with peers.
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Assess cash flow consistency – Are cash flows steady and predictable? Analyze cash flow volatility using statistical tools.
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Review growth rates – Compare cash flow growth rates to revenue growth. Disjointed growth can signal problems.
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Analyze cash flow drivers – Understand the specific activities driving changes in cash flows. This reveals strengths/weaknesses.
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Check working capital – Improper management of working capital accounts like inventory and payables can significantly impact cash flows.
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Monitor cash flow ratios – Key ratios like cash flow adequacy and operating cash flow ratio highlight areas needing attention.
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Compare with budgets – Do cash flows align with budgets? If not, what is the discrepancy telling you?
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Assess sustainability – Can current cash generation sustain target growth rates and required investments?
Regularly conducting this analysis will provide an invaluable understanding of your company’s cash position and ability to meet financial obligations – the lifeblood of any business.
Tips for Improving Cash Flow
Here are some tips for improving your business’s cash flow based on insights from the cash flow statement:
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Optimize working capital – Better manage inventory, receivables, and payables to optimize working capital.
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Control costs – Reduce unnecessary expenditures that don’t contribute to cash generation.
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Offer discounts – Strategic discounts or terms can incentivize early payment from customers.
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Lease equipment – Lease instead of purchasing equipment to conserve cash.
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Outsource functions – Outsourcing peripheral functions conserves capital.
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Invoice quickly – Ensure timely billing and collection from customers.
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Extend payables – Renegotiate payment terms with suppliers to ease pressure on cash reserves.
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Assess pricing – Review pricing levels regularly to ensure adequate cash margin on sales.
Final Thoughts
As you can see, regularly analyzing your company’s cash flow statement provides significant insights that directly impact important business decisions and strategy. The cash flow statement highlights your company’s financial reality regardless of any accounting sleights of hand. Mastering the ability to glean insights from cash flow statements will provide invaluable visibility into the financial viability and sustainability of your business operations.
Cash flow statement example
Following is an example of what a cash flow statement looks like. This is the cash flow statement for XYZ company at the end of Financial Year (FY) 2018.
From the above example, we can see that the computed cash flow for FY 2018 was $ 2,528,000. Let’s look at what each section is showing.
Operating activities: In this section, we can see incoming cash values recorded as positive while outgoing cash values are negative and are usually represented in brackets. When you subtract the outgoing value from the incoming value, you arrive at the net cash flow for operating activities. In this example, we can see that the net value for operating activities is positive, which is a good sign for investors.
Investing activities: Since the core operating activities are generating income, the business can now invest in equipment. Because the company is investing $500,000 in equipment, its cash flow in this section is negative. This negative value isn’t a bad thing—you can say that the company’s capacity to invest in PPE reflects its growth.
Financial activities: After investing in equipment, the company still has $10,000 to pay off its debts—in this case, notes payable. Besides this the company will still have plentiful to cover its loans in future.
Net cash flow: When you add all three net values from the three sections on the cash flow statement, you arrive at the net cash flow value, which in this case is $ 2,528,000. This shows that the company has enough cash to continue operating.
What is a cash flow statement?
A cash flow statement is an important tool used to manage finances by tracking the cash flow for an organization. This statement is one of the three key reports (with the income statement and the balance sheet) that help in determining a company’s performance. It is usually helpful for making cash forecast to enable short term planning.
The cash flow statement shows the source of cash and helps you monitor incoming and outgoing money. Incoming cash for a business comes from operating activities, investing activities and financial activities. The statement also informs about cash outflows, expenses paid for business activities and investment at a given point in time. The information that you get from the cash flow statement is beneficial for the management to take informed decisions for regulating business operations.
Companies generally aim for a positive cash flow for their business operations without which the company may have to borrow money to keep the business going.
What’s so Important about a Statement of Cash Flows?
What is a cash flow statement & why is it important?
Cash flow statements are one of the key documents investors look at when deciding to finance your business or not. Put alongside the profit and loss (income) statement and balance sheet, the cash flow statement reveals the state of your business, which in turn helps investors decide if they trust you with their money.
What is a company’s cash flow?
A company’s cash flow is the figure that appears in the cash flow statement as net cash flow (different company statements may use a different term). The three main components of a cash flow statement are cash flow from operations, cash flow from investing, and cash flow from financing.
Do you know how to read a cash flow statement?
Whether you’re a working professional, business owner, entrepreneur, or investor, knowing how to read and understand a cash flow statement can enable you to extract important data about the financial health of a company. If you’re an investor, this information can help you better understand whether you should invest in a company.
Why do companies examine cash flow?
Companies, investors, and analysts examine cash flow for various reasons, including for insight into a company’s financial stability and health and to inform decisions about possibly investing in a company. The statement of cash flow depicts a company’s sources of money and where it spends it.
