Cash Flow Statement

Q: What is the purpose of a cash flow statement?

A cash flow statement shows how cash moves in and out of a business during a period. It allows businesses to track liquidity, meet obligations, and make financial decisions. Unlike an income statement, it focuses only on actual cash, not accruals.

Q: How do you calculate cash flow from operating activities?

To calculate cash flow from operating activities, start with cash inflows from sales, then subtract direct costs like inventory, wages, and other operating expenses. For example: £20,000 sales - (£8,000 suppliers + £4,500 wages) = £7,500 operating cash flow.

Q: How does a cash flow statement differ from an income statement?

The income statement records revenue and expenses when earned or incurred, while a cash flow statement records only actual cash received and paid out. This distinction makes the cash flow statement a key tool for assessing liquidity.

Q: Why do businesses with profits sometimes have cash flow problems?

Profitable businesses may have cash flow problems if revenue is tied up in unpaid invoices or inventory. For example, large sales on credit increase profits but don’t bring immediate cash, which can constrain operations.

Q: How does a cash flow statement help in business planning?

A cash flow statement helps forecast when cash will be available or needed, enabling better management of expenses, investments, and potential funding requirements. Accurate cash flow projections support strategic decisions and ensure sustainability.

Finance Dictionary >Cash Flow Statement

A cash flow statement is a financial report that summarises the amount of cash and cash equivalents entering and leaving a business during a specific period. It enables stakeholders to assess a company's liquidity, solvency, and overall financial health. Unlike the income statement, which records revenues and expenses when they’re incurred, the cash flow statement focuses solely on the timing and movement of cash. An interesting fact is that even businesses showing profits on their income statement can experience cash shortages, underlining why cash flow statements are vital for financial analysis.

What is Cash Flow Statement?

The cash flow statement is divided into three main sections: operating activities, investing activities, and financing activities. It records, for a given period, all sources and uses of cash. For example, consider a small retailer. Over a month, it receives £10,000 in sales revenue (operating activity), spends £6,000 on inventory, pays £2,000 in wages, and repays a loan of £500 (financing activity). Meanwhile, it buys a new delivery van for £3,000 (investing activity). The statement allows the owner to precisely track the cash position.

Cash Flow Statement Example and Step-by-Step Calculation

Suppose a company reports the following for June: - Cash received from sales: £20,000 - Cash paid to suppliers: £8,000 - Cash paid for wages: £4,500 - Purchase of equipment: £2,000 - Loan repayment: £1,500 - New investment received: £3,500 Step 1: Calculate net cash from operating activities: Operating cash inflows (£20,000) minus outflows (£8,000 + £4,500) = £7,500. Step 2: Calculate net cash from investing activities: Cash outflow for equipment = -£2,000. Step 3: Calculate net cash from financing activities: Inflow from investment (£3,500) minus loan repayment (£1,500) = £2,000. Step 4: Net change in cash position: Operating (£7,500) + Investing (-£2,000) + Financing (£2,000) = £7,500. This calculation means the business’s cash increased by £7,500 during June, reflecting strong operational cash generation even after investments and repaying debts.

Historical Background of the Cash Flow Statement

The importance of the cash flow statement grew in the late 20th century, as businesses and investors realised that profit figures alone did not reflect actual financial health. Formalised in the 1980s by accounting standards boards worldwide, it is now a standard requirement in financial statements, offering transparency for creditors, investors, and management.

How Does a Cash Flow Statement Work?

Every cash movement recorded in the statement falls into one of three categories: operating (core business operations like sales and expenses), investing (activities such as purchasing or selling long-term assets), or financing (borrowing, repaying debt, or new capital infusions). The net effect reflects whether a business is building its cash reserves or consuming them.

Relationship with Income Statement and Balance Sheet

The cash flow statement is closely linked to both the income statement and the balance sheet. Where the income statement may show profit through credit sales, the cash flow statement reveals when the money is actually received. Similarly, changes tracked in assets and liabilities on the balance sheet, such as accounts receivable or accounts payable, are sources and uses of cash explained in detail here.

Common Uses of Cash Flow Statements in Business

Business owners, investors, and lenders use the cash flow statement to judge a business’s liquidity, assess borrowing needs, and evaluate whether it can fund expansion or withstand downturns. For instance, if a company’s cash flow from operating activities is negative, it may rely more on outside financing, which is unsustainable in the long run.

Key Considerations and Best Practices

It’s important for businesses to prepare the cash flow statement regularly and review both short- and long-term trends. Regular analysis can pinpoint timing mismatches in income and expenses, and guide strategy for inventory, working capital management, and investment. The cash flow statement stands alongside other reports such as the income statement and balance sheet, and is vital for comprehensive financial reporting. Understanding and calculating cash flows are critical for planning, loan applications, or presenting to investors. In summary, whether seeking funding, evaluating strategies, or planning for growth, mastery of the cash flow statement empowers business leaders to make informed decisions. Accessing resources such as business funding solutions can also help businesses strengthen their cash position at critical moments.