The cash flow statement can tell us a lot of things; it's one of the savvy business people and investors's favorite reports! So seeing how this report happens to be a favorite, we're really interested in writing about it.
Cash Flow Statement Basics
Firstly and simply put, Cash flow is the measure of how much cash is moving in(generated) or out(used) of your business in a given period of time. For example, during one month, you might pay $5,000 in bills and receive $8,000 in cash from your customers. In this case, your total cash flow would be $3,000. Calculations are as simple as:
Cash Received – Cash Paid Out = Cash Flow
(You can actually read a little more about the differences between Cash Flow and Profits here)
The cash flow statement organizes the information about the cash generated and used by the company in 3 parts:
1. Operating
2. Investing
3. Financing
This is a sample of how a Statement of Cash Flows looks like:
To get a better idea of what each part includes, here are examples of Operating activities: (We are naming only a few)
Inventory Supplies Prepaid Expenses (ex insurances)
Accounts Receivable (AR)
Accounts Payable (AP) Wages Payable Payroll Taxes Payable
Sales Taxes Payable
Income Taxes Payable, etc...
The operating activities section shows a company's cash flows from its core business operations, which it uses to reinvest in and grow its business.
Examples of Investing activities:
Long-term Investments Land, Buildings Equipment Furniture & Fixtures Vehicles, etc...
The investment activities section shows the cash flows from buying and selling long-term assets, such as equipment and property.
Examples of Financing activities:
Notes Payable Bonds Payable
Dividends Payable Deferred Income Taxes Preferred Stock
Retained Earnings Paid-in Capital from Treasury Stock Treasury Stock, etc...
The financing activities section shows cash flows from issuing and paying off outside financing, such as stock, banks and debt, and from paying dividends.
Few things the statement of cash flow is telling us
If the company is generating cash or using cash.
A healthy business should generate positive net cash flow from operating activities and should grow the amount over time. If a business fails to consistently generate positive net cash from operating activities, it may need to rely on outside financing to operate, which will not sustain a business long term.
The cash from operating activities is compared to the company's net income. If the cash from operating activities is consistently greater than the net income, the company's net income or earnings are said to be of a "high quality". If the cash from operating activities is less than net income, a red flag is raised as to why the reported net income is not turning into cash.
If the operating cash flow total is negative, the company is losing money.
A stable or growing business typically has negative net cash flow from investment activities, which occurs when it buys more assets than it sells. A growing business routinely invests in new assets to expand its capacity, replace old equipment and to keep up with new technology.
A healthy business may occasionally show positive net cash flow from financing activities as it raises money from investors and creditors to grow its business, but a healthy business should more often show negative net cash flow from financing activities. A negative amount suggests the business is using its cash flow from operating activities to pay dividends and pay off its outside financing.
Some investors believe that "cash is king". The cash flow statement identifies the cash that is flowing in and out of the company. If a company is consistently generating more cash than it is using, the company will be able to increase its dividend, buy back some of its stock, reduce debt, or acquire another company. All of these are perceived to be good for stockholder value.
If the financing section shows that they are paying dividends, but have a negative operating cash flow, a red flag is raised. They are likely borrowing money to actually pay dividends.
If the AR are negative, it means that clients are using credit, they are taking a certain amount of time before paying the company, and if they are positive it means clients are paying on the spot or very fast, in the following few days.
If the AP are negative, it means that you are paying on the spot or very quickly, and alternatively if they are positive it means you are using the credit terms and paying later, for instance after 30 days.
Predict Your Cash Flows and Never Have Surprises
To push it a bit further, let's introduce the cash flow forecast, or projected cash flow. Even if you have the best sales strategies and the strongest team, it all means nothing if you don’t have enough money to pay the bills. So, imagine being able to forecast, to predict the money your business is going to need, and when it’s going to need it.
We can see in the sample graph below that this company was going to have a bank account in the negative for certain months; February to July to be precise. This precious tool, the Cash Flow Forecast, allows a manager to take actions now in order to change the situation and actually have money in the bank during these negative predicted months. But without the tool, he had no way to know, unless he has a good intuition.
Onyxia Accounting can build your personal cash flow forecast; help you predict when your bank account might run low and help your business make decisions. Contact us for details and we'll be happy to help your business succeed.
I really hope you liked that article, it's so important to know these basic principles that many businesses could be saved if they understood this report, and the difference between Profits and cash flows, as well as knowing that profits don't equal money in the bank.
Do not hesitate to share,
Nadine LeBrun
President & Founder
Onyxia, Comptabilite | Accounting