Let us start with, “What is the cash flow statement?” to understand the significance of this document to your business. The cash flow statement gives detailed information on the cash generated and spent during the specified accounting period. You could easily use online accounting software to prepare it monthly, quarterly, or yearly.
Why is the Cash Flow Statement Prepared?
In addition to the cash flow statement, income statement and balance sheet also report on how the money flows through a business. However, the income statement gives details about profits but not about the cash components. On the other hand, a balance sheet captures a snapshot of the status at a particular date.
Importance of Cash Flow Statement
The cash flow statement bridges the information gap between the income statement and balance sheet by recording the flow of money. It reveals how effectively the business has been using its cash. It helps you in adjusting business strategy if you have a negative cash flow. Or, in using cash to grow your business if it is positive.
The cash flow statement is an important document, especially when you want to raise capital. It is the first thing that investors like banks, financial institutions, and individuals want to examine. They, along with your current stakeholders, love to back businesses having positive cash flow.
It is why you must prepare, depending on your business needs, a consolidated or full cashflow statement using accounting software. It is a simple way of showing investors how much your business is worth and building their faith in you.
What is an Inflow of Cash?
Cash inflow, as the term suggests, is the money flowing into your business. Money from sales, investments or financing activities of your business is your inflow of cash.
Cash outflow, as you may guess, is the money flowing out of your business through expenses and purchases.
Benefits of Preparing a Cash Flow Statement
You can diagnose the health of your business by comparing its cash inflow against outflow. Investors often do the same and invest in companies having positive cash flow. A well-prepared cash flow statement:
- Renders details about the liquidity & solvency of your business
- Provides info on historical cash flows which you can use to forecast future cash flows
- Summarises financial status of your business and shade light on the priorities of management
- Provides a basis for comparing your business’ performance with that of other’s
What Should a Cash Flow Statement Include?
Depending on your business’ activities over the specified accounting period, you should generate its cash flow statement to include: Operating, Investing and Financing cash flows.
Operating Cash Flow
Operating cash flow should cover your business’ main activities that generate revenue. This section of the statement details cash flows from sales, purchases and other expenditures.
- Cash inflows from sales
- Cash from earnings on investments
- Payments for purchases from suppliers
- Payments to employees
- Payments for interest and taxes
- Increases or decreases in accounts receivable or payable
- Increase or decrease in inventory and prepaid expenses
Investing Cash Flow
Cash flows also arise for your business when you invest in activities like an acquisition or when you dispose of its non-current assets. This type of cash flows arises through purchase and sales of:
- Equipment, real estate, buildings, vehicles and machinery
- Short-term investments; and
- Acquisitions and dispositions of assets
Financing Cash Flow
You may decide to borrow money from the banks or other financial institutions or to issue shares to achieve your business goals. These activities generate cash flows for the business. You need to cover such cash flows in financing cash flow section of the statement:
- The rise in debt, bonds and notes payable
- The rise in capital from stockholders
- Expenditure for stock buybacks
- Expenditure on loan repayment
- Payments of dividends
The information presented shades light on how the size and nature of the equity capital or borrowings of your business have changed.
How to Prepare a Cash Flow Statement for a Small Business: Direct or Indirect Method
Keeping with your accounting needs, you could ask your accountant to use the direct and indirect presentation of operating cash flow.
- How to Prepare a Cash Flow Statement Direct Method: This is a rarely used way of representing a business’ cash flow. It is a straightforward listing of your business’ cash flow. It depicts cash-in from sales and cash-out due to your capital expenditures.
- How to Prepare a Cash Flow Statement Indirect Method: This method depicts financial information as a reconciliation from profit to cash flow. It may not always show actual cash flows, but it may explain away why cash flow differs from profit. Depending on your needs, you can use operating profit, profit before or after-tax, or net income of your business for the purpose.
As a small business owner, you are responsible for your business’ accounting and monitoring its financial performance. And, measuring it in terms of high or low profit is not all that good idea. You need to prepare a cash flow statement to get a true measure of financial status. You can automate the process using the best accounting software and save a lot of time and efforts.