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What is a cash flow statement and why is it important? – Reports Part 4

cash flow statement

The Cash Flow Statement (CFS) is where the rubber meets the road. What do I mean by that? In the previous post, we looked at the balance sheet and the income statement; in the 3rd report, the idea of cash flow is where you can see the actual cash inflow and cash outflow.

If you are one of the many business owners who runs his/her business by looking at the cash inflow and outflow in the bank account, this report, although widely misunderstood, will tell you exactly where your money is coming from and where it is going to.

In this post, I will explain the Cash flow Statement in its basic form so keep reading.

Components of the Statement of Cash Flows

Operating Activities:

Cash flow from operating activities is a company’s cash flow statement category. Cash Flow Statements show how much cash came into the company and where that cash went. Cash flow from operating activities is the cash generated by a company’s regular business operations.

This includes cash from product sales, royalties, commissions, fines, lawsuits, supplier and lender invoices, and payroll. Cash flow from operating activities is vital because it shows how much cash a company generates from its core business. This number is used by financial analysts to assess a company’s financial health. Cash flow from operating activities is also essential for management because it shows how well the company generates cash to fund its operations.

Investing Activities:

Investing activities are cash payments to acquire long-term assets, such as property or equipment. They also include cash received from the sale of long-term investments. Examples of investing activities are the purchase of fixed assets and the purchase or sale of securities issued by other entities. Cash flow from investing activities is shown on the Cash Flow Statement as a separate line item. This information is essential because it helps investors understand a company’s financial health.

Financing Activities:

Cash flow from financing activities is one of the significant categories of cash flow statements. Cash flows from financing activities include money received from issuing debt and equity instruments and cash paid out to repurchase or retire debt and equity instruments.

Cash flows from financing activities also include dividend payments. The cash flow from financing activities section of the cash flow statement provides information about a company’s capital structure and how it has changed over time.

This information is helpful for investors and creditors in assessing risk. Financial statement analysis often includes a review of a company’s cash flow from financing activities. This analysis can provide insights into a company’s short-term and long-term financial health.

It can also help investors and creditors assess the riskiness of a company’s capital structure. Cash flow from financing activities is reported on the cash flow statement, one of the three primary financial statements used in accounting. The other two financial statements are the balance sheet and income statement. Together, these three financial statements provide a complete picture of a company’s financial health.

Methods of Calculating Cash Flow:

Direct Method:

The direct method of CFS is a straightforward way for small businesses that use the cash basis accounting method. This process includes all transactions involving payments made with funds from customers and company expenses, such as salaries paid out or materials purchased on account (I). 

The net decrease in these accounts could then be analyzed at any given time via this straightforward approach; its simplicity makes it worthwhile when pinpointing problems within your books!

Indirect Method:

The indirect method is a great way to calculate cash flow because it considers any non-cash transactions that may have happened within your company’s finances. This means you can identify increases and decreases in assets or liabilities from one period, which will be added back when calculating net income for an accurate Cash Inflow!

The changes in accounts receivable (AR) on the balance sheet from one accounting period to another must be reflected by adjusting cash flow. If AR decreases, more money has come into the company as customers pay off their credit balances -the amount by which it’s reduced can go towards increasing net earnings since this represents a cash inflow.

Here’s how company inventory changes are accounted for on the CFS. An increase signals that more money was spent on raw materials, and using cash means this addition will also decrease earnings deducting from them over time! A decrease would add to net profits because credits were purchased at one point but not paid yet – so when they’re finally settled out, these additional amounts can be added into what is already there instead of creating two accounts like before, where everything had its line item: One with purchases made last year which got subtracted during Hopefully.

The logic behind taxes, salaries, and prepaid insurance is similar. If something has been paid off, then the difference in value from one year to another needs subtraction, while if there’s an amount still owed, it will have been added on top of your net earnings.

The same rules apply for all three: pay as you go (or buy up-front), and make sure whatever expense goes into this account doesn’t come out before selling any products/services that generate revenue over time rather than eventually.

Lessons to take with you

  1. It is important not to automatically raise the red flag on poor cash flow. Sometimes, this can signify that your company has decided it’s time for expansion and is trying new strategies to grow its businesses further down the road.
  2. The indirect cash flow method is excellent for reconciling your income statement and balance sheet. The reconciliation process lets you know how much money was made, where it went (income or expense), and any increases in assets that may not be fully covered by expenses like stocks/comps, etc…

Conclusion

If you have an accounting program like Quickbooks, go ahead and pull up the cash flow statement. See if you understand it. If you need help, please contact me for a free consultation by clicking on the button below.

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