The Cash Flow Statement

The cash flow statement reflects three categories: cash flow from operations, cash flow from investing, and cash flow from financing.  It it one report in the set of fundamental financial statements.   It is useful for businesses that are using the accrual method of accounting.  Let’s discuss the reasons why you want a cash flow statement for an accrual accounting system.

For businesses, there are two forms of accounting: cash and accrual.  For businesses that use cash accounting, it means that they do not record invoices (or “sales”) until they receive the full payment for that sale.  Bills from vendors post the same way. They post in the accounting system right away.   For example, a small coffee shop will likely choose a cash basis accounting system.  The reason is they pay their bills and receive payments at the time of the transaction.

If a business is making at least $1million in sales in a year, however, it must use an accrual basis of accounting.  Translated, all sales post right away.  Payments, on the other hand, do not need posting right away.  With that in mind, a cash flow statement is critically important for the business executives.  Goods or services sold affect inventories and/or payrolls, but payment can be made later.  As a result, cash must be on hand ahead of time to pay for various costs to do business.

A Definition

Investopedia explains the cash flow statement this way:

“The first set of cash flow transactions is from operational business activities. Cash flows from operations starts with net income and then reconciles all noncash items to cash items within business operations. For example, accounts receivable is a noncash account. If accounts receivables go up, sales were made, but no cash was received right away. The cash flow statement deducts receivables from net income because it is not cash. Also included in cash flows from operations are accounts payable, depreciation, amortization and numerous prepaid items booked as revenue or expenses but with no associated cash flow.

“Cash flows from investing activities includes cash spent on property, plant and equipment. This is where analysts look to find changes in capital expenditures (CAPEX). While positive cash flows from investing activities is a good thing, investors prefer companies that generate cash flows primarily from business operations, not investing and financing activities.

“Cash flows from financing is the last business activity detailed on the cash flow statement. The section provides an overview of cash used in business financing. Analysts use the cash flows from financing section to find the amount paid out in dividends or share buybacks. Cash obtained or paid back from capital fundraising efforts, such as equity or debt, is also listed.”

In simple terms, a business is threatened if sales continue to be posted, but the business isn’t receiving payments.  The cash flow statement shows the business executives if payments are coming in – or not.  It also tells the business executives where the cash is going, once it enters the business.  Both areas are very important to monitor.