A cash flow statement keeps an account of the cash inflows and cash outflows of a business i.e. how much money comes inside the business and how much goes outside the business, cash flow statement keeps that record. If you have a business, or you are a business student, you must have heard the term “cash flow statement.” If you haven’t heard, no issues, because here we’ll discuss -what is a cash flow statement? How important is it for business?
What is a Cash Flow Statement?
A cash flow statement is a financial statement that explains the summary of inflows and outflows of cash and cash equivalents of a company. This statement estimates how well a company manages its cash position i.e. how well the company pays its debts and carries its operating expenses by generating cash. It’s one of the three major financial statements and complements the balance sheet and income statement.
How Do You Use a Cash Flow Statement?
The cash flow statement depicts a complete picture of how a company’s functions are running, from where the money comes, and how the money is spent. Its another name is a statement of cash flows. This statement helps its creditors to determine how much cash a company has to bear the costs of its functions and pay its debts. A cash flow statement is equally important for investors because it lets them know how strong the financial base of a company is. It means that they can make better and more meaningful decisions regarding their investments using this statement. So, whether you are an owner, creditor, or investor of a business, you can use this statement to know the cash situation of a company.
Why is the Cash Flow Statement Important?
A cash flow statement calculates a company’s cash inflows and outflows for a certain period of time. Such detailed information about the cash position of a company not only helps the company, or its financial analysts in developing short-term or long-term plans but also helps to know the optimum level of cash for the company and analyze the amount of working capital.
The source and use of cash are divided into three classes. These are:
Cash Flow from Operating Activities:
This part is crucial because it concentrates on the major business operations like product sales and buying, service providing, and the like. Operating activities consist of receivables from the sale of products and services, income tax payment, interest payment, payments made to suppliers for the products and services used in the production, rent payment, salary, and wages paid to employees, and all other types of operating activities.
Cash Flow from Investment Activities:
This part of the cash flow statement holds importance because it gives a detailed description of the purchase and sale of a company's capital assets, i.e. according to the balance sheet, the beneficial life of which assets are greater than one year. Investment activities consist of any type of source and use of cash from the company’s investments. Assets’ purchase and sale, paid loans to lenders, or any payment related to merger and acquisition falls under this category. Precisely, changes in assets, equipment, or investment is associated with the cash flow from investment activities.
Cash Flow from Financing Activities:
This section of the cash flow statement is vital because it considers the company's share purchasing and selling, payment of debt financing, and other sides. It means this statement reflects that part of the company’s cash flows which is the net cash flows that are used to finance. Cash flow from financing activities consists of cash from banks and investors, and the way cash is paid to shareholders. It consists of any kind of dividend, payment of share repurchases, and payment of debt principal.
How a Cash Flow Statement is Important for a Business?
Let’s discuss in a bit more detail how a cash flow statement is important for a business. A cash flow statement holds immense importance for a business in the following ways:
- Short-term Planning
- Description of Spending Activities
- Creating Extra Cash
- Expresses the Outcomes of Cash Planning
- Informs the Best Optimum Level of Cash Balance
- Analysis of Working Capital
- Crisis Management
- Long-term Planning
- Prioritizing Essential Functions
- Reducing Expenses and Eliminating Wastage
Let's discuss each of these points separately.
1. Short-term Planning
A cash flow statement plays a quite important role in short-term planning and cash management. Each business should keep a certain amount of cash funds so that if any sudden need arises or to meet different daily requirements, it doesn’t face any problem-solving. A cash flow statement helps a financial manager to quickly detect present cash flows by informing the past information about past cash inflows and outflows. As a result, s/he can use that cash frequently according to the requirements.
For instance, a company can have different necessities and it requires cash to fulfill those such as payment of salaries and wages, payment of debts, and other different operating expenses.
2. Description of Spending Activities
A cash flow statement depicts a complete picture of the different types of expenditures of a company in an awesome way. For instance, your company has taken a loan and has paid the debt principal. This transaction won’t be mentioned in your company’s profit and loss account, instead it will be mentioned in the cash flow statement. It can also happen such that your company has made a profit that is mentioned in the profit and loss account, but after making the payment of the debt principal your business might not have any cash flow left. In such a situation, if any requirement arises, your business won’t have any cash to meet that. The cash flow statement will help you to recognize this situation.
3. Creating Extra Cash
Every business goes ahead with the motive of making profits. But you should never forget that there are also other ways to create cash other than making profits. You can recognize these methods from the cash flow statement. Conversely, if you concentrate only on the profit and loss account, it will become tough for you to find out ways of creating cash. For instance, you can create extra cash by collecting the receivables from your customers quickly, utilizing the inventory efficiently, etc.
4. Expresses the Outcomes of Cash Planning
Generally, businesses make cash plans to make sure that their projects are fruitful. A cash flow statement will let you analyze whether your company’s cash planning is effective or not by comparing the actual cash flow outcomes with the estimated cash flow figures. Thus, you can decide well about whether you will require more cash in the future and do better planning by comparing your company’s cash flow statement and cash budget.
Generally, businesses make cash plans to make sure that their projects are fruitful. A cash flow statement will let you analyze whether your company’s cash planning is effective or not by comparing the actual cash flow outcomes with the estimated cash flow figures. Thus, you can decide well about whether you will require more cash in the future and do better planning by comparing your company’s cash flow statement and cash budget.
Suppose, your company assumes that on any specific month you will have an expenditure of BDT 20,000 on capital assets, but the actual expenditure is BDT 30,000. Your company should identify such differences between estimated and actual costs, and take measures accordingly.
5. Informs the Optimum Level of Cash Balance
A cash flow statement lets you know the best optimum level of cash balance. You must know the optimum level of cash balance because you will be able to know whether your company has idle money, surplus fund, or deficit fund. Your company’s managers can make decisions accordingly after knowing the actual situation of cash.
Suppose, you have surplus cash and idle funds in your business. In that case, the company can invest that surplus cash, or if there is a cash deficit, you can decide if you need to take a loan from outside such as banks, financial institutions, or investors to fill up that deficit.
6.Analysis of Working Capital
Working capital is a component of cash flow from operating activities that affect the cash flows of the company. So, investors should be aware of the company’s movement of working capital.
For instance, you come to know from the cash flow statement that your company has a cash deficit. Then, you can conserve your company’s cash by delaying the time of bill payment. You can increase the company’s cash inflows by decreasing the time of collecting receivables from the debtors, and you can also conserve cash by delaying the purchase of inventory.
7. Crisis Management
A cash flow statement can help in crisis management because it informs a business’s investors or shareholders whether it has a cash surplus or cash deficit. If a manager can identify a probable cash deficit in the future, he can take effective measures to tackle that situation. It plays a huge role to help the company reach its target goals.
8. Long-term Planning
A cash flow statement helps a company in its long-term planning apart from helping in short-term planning. A company’s growth depends on the right long-term planning. A cash flow statement helps managers to identify certain and implementable changes. These changes gradually let the company reach a strong financial condition quite well.
For instance, targeted or estimated cash flows help the managers of the company to identify possibilities of long-term debt payments because it relies upon the availability of cash.
9. Prioritizing Essential Functions
As the cash flow statement helps the company’s managers in short-term and long-term planning, then they can identify different short-term and long-term problems. According to that, they can prioritize the essential functions or activities.
10. Reducing Expenses and Eliminating Wastage
A cash flow statement lets you identify whether a certain work, project, or strategy is successful, needs improvements, or should be removed. Thus, a cash flow statement helps you to reduce expenses and eliminate wastage.
Final Words
Now, you must have understood -what is a cash flow statement? How important is it for business? So, utilize the cash flow statement accurately for the development of your business without any delay. HisabPati is an excellent app that will help you keep all your business accounts accurate, and prepare different financial statements along with cash flow statements. Our best wishes are with you!
