If you want to understand and analyze a cash flow statement, read this:
The cash flow statement summarizes the cash generated and spent over a specific time period (for example, a month, quarter, or year).
It shows an organization’s ability to operate in the short and long term based on how much cash is flowing into and out of it.
THE IMPORTANCE OF A CASH FLOW STATEMENT
Since the balance sheet and the income statement report the activities of a company on an accrual basis, it is crucial to have a statement that reports cash over a period. And this is what the cash flow statement provides.
Note that cash flow is different from profit, which is why a cash flow statement is interpreted with other financial documents.
A profit is the amount of money left over after all expenses have been paid; cash flow indicates the net flow of cash into and out of a business.
COMPONENTS OF A CASH FLOW STATEMENT
Cash flow statements are broken into three sections: cash flow from operating activities, cash flow from investing activities, and cash flow from financing activities.
• Operating activities are the main revenue-producing activities of the entity. They include the cash flows associated with sales, purchases, and other expenses.
• Investing activities comprise cash flow from the acquisition or disposal of assets using free cash and not debt; this is usually in the form of physical property, such as real estate or vehicles, or non-physical property, like patents.
• Financing activities from changes in a company’s capital structure.
It includes cash flows from borrowing and repaying bank loans or bonds, as well as issuing and repurchasing stock.
HOW TO CALCULATE A CASH FLOW
There are two methods: Direct and Indirect
Direct Method
Operating cash flows are presented as a list of cash flows: cash in from operating activities and cash out for operating expenses. This method is not used frequently in companies.
Indirect Method
It is based on the accrual accounting system, where revenues and expenses are recorded at periods other than when cash is paid or received, causing the cash flow from operational activities to deviate from net income.
In the indirect method, the net income from the income statement is the starting point and adjustments are made to undo the impact of accruals during the period.
The goal is to remove any non-cash expense, such as depreciation and amortization, and capture all cash activities.
CASH FLOW INTERPRETATION
A positive cash flow implies that a business has more money flowing into it than out of it over a given time period.
This is good news because it gives the company the ability to deploy cash to grow the business or repay its debt.
A negative cash flow means cash outflows are higher than cash inflows.
This can be caused by a mismatch between revenue and expenses or by a decision to invest in future growth.
This is why the change in cash flow needs to be analyzed over time for a better assessment.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
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