Introduction
‘Cash is king’ is a popular saying that you might’ve heard. This is particularly true for all types of businesses, as cash is a measure of their financial standing in the long run. Hence, cash management is an essential skill to sustain the ongoing activities of a business, mobilize funds where needed and optimize its liquidity. A company’s liquidity can accordingly be measured adequately via its financial statements – income statement, balance sheet and cash flow statement.
Statement of Profit & Loss or Income Statement: An account of all the revenues and expenses of a firm during an accounting period, which then ascertains the net profit (or loss).
Balance Sheet: A summary of a firm’s total assets, liabilities, and capital. As a result, it evaluates the firm’s financial standing at the end of an accounting period.
Cash Flow Statement: A report of all cash inflows and cash outflows incurred by a firm in an accounting year. That is, it determines the net cash utilized/generated by the business.
Let us take a closer look at what is cash flow statement, its examples, and the cash flow statement format.
Cash Flow Statement Meaning
In general, a cash flow statement is a financial statement that details a company’s inflows and outflows of its cash and cash equivalents. Cash equivalents simply refer to those assets that can be converted into cash immediately, like bank accounts and marketable securities.
A key objective of the cash flow statement is to lay out how much cash is moving and in which direction. Furthermore, it helps a business understand how much net cash they are generating from their operating, financing, and investing activities.
Thus, the cash flow statement acts as a bridge between the income statement and the balance sheet. For instance, we can infer from the balance sheet a change in the cash position of a company from Rs 1,00,000 to Rs 2,00,000 in a particular year. On the other hand, the cash flow statement highlights the activities which have resulted in this net cash inflow of Rs 1,00,000.
It also evaluates the financial performance of a company, just like the income statement. However, CFS gives an entirely different result, as it is not affected by non-cash transactions. Basically, the income statement reflects a company’s performance via its revenues, expenses by determining its net profit/loss for a given period; whereas, a cash flow statement shows how that profit or loss moves across the company.
Cash vs Non-Cash Transactions
Cash transactions are those transactions directly involving the inflow and outflow of cash and cash equivalents. For example, cash sales, interest paid or received, cash purchases, sale/purchase of fixed assets using cash or bank balance.
Non-cash transactions are those transactions that do not have an actual cash flow associated with them. One major example of such a transaction is depreciation. Depreciation is the distribution of the cost of an asset over its useful life.
For example, a company buys a machine for Rs, 10,00,000 and estimates its useful life to be 5 years. So, the company decides to spread this expense equally over the years, instead of writing it down as a single, big expense. Dividing Rs 10,00,000 by 5, gives us depreciation of Rs 2,00,000 every year for the next 5 years. However, no cash was actually paid out when these expenses were recorded, so they appear on the income statement as a non-cash expense.
Now that we have some idea as to what is cash flow statement, let us dive deeper into its intricacies and understand what constitutes a cash flow statement.
Components of Cash Flow Statement
Cash flow from Operating Activities
Operating activities are the day-to-day business activities of a company. For example, a grocery shop’s business activities could be buying and selling groceries. Therefore, the cash spent or earned from operating activities is the cash flow from these operating activities.
Examples of operating activities include income tax payments, payments made to suppliers, salary and wages to employees, rent payments, etc.
Cash flow from Investing Activities
The next component is cash flow from investing activities. Investing activities are integral to a business as, without these activities, the business cannot conduct its day-to-day operations. As a result, the business would be unable to determine its cash flow from operating activities. For example, a manufacturing firm has to acquire relevant plant and machinery in order to produce finished goods.
The cash spent or earned from buying or selling fixed assets refers to cash from investing activities. Put simply, any payment regarding a company’s changes in equipment, plant, long-term investments, etc., are included in this section. Some common investing activities include purchasing fixed assets, stocks, bonds, securities, selling off securities, etc.
Cash flow from Financing Activities
Lastly, to invest in assets, so that a firm can run its operations and generate profits, it needs funds – which can be raised via financing activities. Financing activities are those transactions that affect the capital or long-term borrowings of a company.
These can be – positive cash flows, like capital raised from investors, issuing shares, debentures, etc. or negative cash flows, like repurchasing stock, paying dividends to shareholders, repayment of loans, etc. So, net cash generated or utilized in these activities is the cash flow from financing activities.
How to prepare the Cash Flow Statement format?
Calculate Cash Flow from Operating Activities
Calculating the operating cash flow is the first and most important step of the process. This is because it reveals the cash flow generated by the day-to-day activities of the company, like sales, purchases, etc.
There are two methods of determining operating cash flows: Direct Method and Indirect Method. It is important to note that the resultant cash flow will be the same through either method.
The Direct Method
The direct method is straightforward and simply adds all cash receipts and subtracts all the payments that the business incurs. This method is more favorable for small businesses as they have fewer transactions to evaluate. Refer to Table 1 for a detailed example.
The Indirect Method
Since companies generally use the accrual basis of accounting, i.e., they record transactions when they are incurred and not when cash is exchanged, incomes shown on the income statement do not indicate the actual amount of cash-in-hand.
Conversely, in the indirect method, the company selectively reverses the transactions from the income statement and adds or deducts balance sheet items from the net income – to arrive at cash generated from operations. A general formula for calculating operating cash flow is:
OCF = Net income + Non-cash expenses – Increase in current assets + Decrease in current assets + Increase in current liabilities – Decrease in current liabilities
Non-cash expenses are added back as they do not involve an actual cash inflow or outflow, like depreciation, amortization.
An increase in current assets is subtracted as the company incurs a cash outflow in order to acquire more current assets; whereas, a decrease in current assets is added to the net profit, as it results in a cash inflow.
For example, if a company increases its inventory, it would’ve made some purchases, which ultimately leads to outflow of cash and cash equivalents. Similarly, if the company sells some of its stock, it would result in a cash inflow.
A decrease in current liabilities is subtracted as there is a cash outflow when a company pays off its liabilities; whereas, an increase in current liabilities is added as the company incurs a cash inflow when it acquires a new liability.
For example, if a company raises a short-term loan, it would lead to a cash inflow. On the contrary, repayment of the short-term loan will lead to a decrease in cash and cash equivalents. Refer to Table 2 for detailed example.
Calculate Cash Flow from Operating Activities
The next step is calculating the cash flow of all investing activities like buying and selling of non-current assets. For example, buying or selling machinery. Buying fixed assets would be considered as a cash outflow. Whereas, selling any fixed assets would result in a cash inflow.
Calculate Cash Flow from Financing Activities
The next step of calculating cash flows is calculating the cash flow generated from financing activities. Mainly, it includes cash flows that affect the debt-equity composition and size of a company. Such as paying interest on loans, dividend payments, taking bank loans, issuing debentures, etc.
Determine the Opening and Closing Balance
The last step of preparing a cash flow statement is determining the opening balance and the closing balance of cash and cash equivalents of the reporting period. By and large, this can be easily determined from the balance sheet of the company.
The difference between the opening and closing balances is the sum of net cash flow from all the activities. Notably, this can also be seen as a way to cross-verify whether or not the net cash flow determined by the cash flow statement is correct or not.
A positive net cash flow indicates that the business had more cash inflows than outflows. On the other hand, a negative cash flow indicates that the business had more cash outflows than inflows.
Examples of Cash Flow Statement
Example One [1]
Cash flow statement 1 Direct method
|
Cash flow from operations
|
₹
|
₹
|
|---|---|---|
|
Receipts from customers
|
4,58,00,000
|
|
|
Cash paid to suppliers
|
(2,98,00,000)
|
|
|
Cash paid to employees
|
(1,12,00,000)
|
|
|
Net Cash generated from operations
|
48,00,000
|
|
|
Interest paid
|
(3,10,000)
|
|
|
Income taxes paid
|
(17,00,000)
|
|
|
Net cash from operating activities
|
|
27,90,000
|
|
Cash flow from investment activities
|
|
|
|
Purchase of property, plant, equipment
|
(5,80,000)
|
|
|
Proceeds from sale of equipment
|
1,10,000
|
|
|
Net cash from investing activities
|
|
(4,70,000)
|
|
Cash flow from financing activities
|
|
|
|
Cash from issuing stock
|
10,00,000
|
|
|
Cash from issuing long-term debt
|
5,00,000
|
|
|
Dividends paid
|
(45,00,000)
|
|
|
Principal payments under lease obligations
|
(10,000)
|
|
|
Net cash used in financing activities
|
|
10,40,000
|
|
Net increase in cash and its equivalents
|
|
33,60,000
|
|
Cash at the beginning of the period
|
|
16,40,000
|
|
Cash at the end of the period
|
|
50,00,00
|
In this example, there is a positive cash flow in the company. Moreover, most of its cash is generated through operating activities, indicating a healthy business.
Example Two
Cash flow statement 2 Indirect method
|
Cash flow from operations
|
₹
|
₹
|
|---|---|---|
|
Net income
|
60,000
|
|
|
Additions to cash
|
|
|
|
Depreciation
|
20,000
|
|
|
Increase in notes payable
|
10,000
|
|
|
Subtractions
|
|
|
|
Increase in accounts receivable
|
|
|
|
Increase in inventory
|
(30,000)
|
|
|
Net cash from operations
|
|
40,000
|
|
Cash flow from investment activities
|
|
|
|
Purchase of equipment
|
(5,000)
|
35,000
|
|
Cash flow from financing activities
|
|
|
|
Long term loans
|
7500
|
42,500
|
|
Cash flow for the month ended 31 December 2020
|
42,500
|
|
- In this example, the cash flow of the company is positive.
- As can be seen, the liabilities of the company are low, and the operating activities generate ample cash.
Uses of Cash Flow Statement
Creditors and investors
Firstly, investors use the CFS to deduce whether a company is on sound financial footing. They look at where the company is getting its cash. If the company has a positive cash flow from operating activities, it is seen as a good investment. Whereas a company generating cash from selling stocks is seen as a dubious investment. In addition, creditors use the CFS to establish whether the company can pay its debts while maintaining its operations.
Potential employees or contractors
Employees or contractors use the cash flow statement to know whether the company can afford compensation for their labour.
Company directors
Company directors are accountable for the governance of the company. Hence, they use the CFS to keep track of the company’s financial situation while making sure that the company does not trade whilst insolvent.
Company directors
A cash flow statement is a cash management tool used by companies to ascertain where their trouble spots are by detailing their sources of cash inflows as well as outflows. It helps to determine a company’s liquidity position and financial health. Having a positive cash flow is indicative of a sound financial position, however, that may not always be the case. For instance, a net negative cash flow might be indicative of a company’s expansion strategy.
Leave a Reply