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Everything You Need to Know About a Cash Flow Statement

By Tomer Goldstein
January 23, 2020

Are you considering selling your products on credit? Do you want to offer your customers the option to make monthly installment payments? We all have important decisions to make in how we run out business, but none is more important than making sure we have enough cash on hand to pay our expenses or make investments necessary for growing our business.

Cash is the engine that drives everything, but most especially our businesses. Most successful companies fail, not for lack of hard work, or a good business idea or plan, but for lack of positive cash flow. Can you afford to hold large inventory in warehouse or sell your inventory on installment if you need the cash immediately to pay your supplier and employees?

Knowing how much income is coming in and out of a company is important to understanding the company's financial health. Most small and medium businesses have a max of 2 months cash on hand to cover expenses in the event of an emergency. It is important to always ensure that your company is sufficiently liquid to cover all your expenses and keep the lights on.

What is the Cash Flow Statement?

The Cash Flow Statement is one of three major financial statements used to show a company's financial health, the other 2 being the balance sheet and the profit and loss statement.

The cash flow statement is used to show cash transactions over a specific period of time, usually monthly, quarterly or annually. The cash flow statement includes cash and cash equivalents, and shows if cash has come in to the company, or has been paid out.

The cash flow statement is broken down into 3 parts:

  1. Cash flow from operating activities – This is broken down into the (hyperlink direct and indirect) methods of accounting, and shows the purchase and sale of goods, and well as other operational activities.
  2. Cash flow from investing activity – This shows the purchase and sale of long-term assets.
  3. Cash flow from financing activities – This shows a company raising capital, paying dividends, loans and other lines of credit and the repayment of such loans, and the issuance of shares.

Cash Flow Basics

Cash flow is the amount of money coming in or out of a company. It is a primary indicator of financial health, showing how efficiently a company is running and if it is able to pay its bills and make investments necessary to support its growth.

A business which is cash flow positive is indicative of its ability to pay its short-term debts. However, a business which is cash flow negative is indicative of the company having more debt than income, and that the company will have a hard time paying its bills unless it raises more capital

There are times however when a company is intentionally cash flow negative, such as when a company is investing in major long-term investments, , going through a launch, or focusing on massive customer acquisition. However, under most circumstances, companies would prefer to be cash flow positive.

Start up companies are a good example where negative cash flow is expected for the first few years while the company is building itself up and growing its consumer base. For this reason, startups need to raise a lot of capital in the early stages of development because they cant finance the company themselves. In recent years, this financing structure has become heavily criticized as large companies such as Uber and WeWork continue to remain cash flow negative many years after their inception. Many economists debate whether this corporate financing model is sustainable in the long term.

Cash Inflow and Outflow

Any income from sales of goods and services, or sale of assets converted into cash are cash inflows. Cash used to pay expenses or purchase investments, materials and goods are cash outflows.

There are fixed and recurring cash flows, and one-time cash flows. Recurring cash flows are typically predictable.

A recurring positive cash flow would be money regularly paid by customers to your company to purchase of your goods and services, such as a monthly subscription fees paid by customers every month (think magazines or Netflix).

A recurring negative cash flow would be repeating expenses such as payroll or monthly insurance premiums.

One-time positive cash flow would be the sale of equipment or land, and a one-time negative cash flow would be the purchase of land, or payments made as a result of a lawsuit.

A company always aims to have more recurring positive cash flow than recurring negative cash flow.

How to Create a Cash Flow Statement

In creating a cash flow statement, it is important to understand the differences between the direct and indirect methods.

The Direct Method

The direct method simply lists all of the cash inflows and outflows of a company during a specific period. Cash from customers, payroll, loans, investments, utilities, and supplier payments are all noted line by line in a direct cash flow statement. For businesses managing their books on a cash basis method, the cash flow statement and the profit and loss statement will look the same.

The Indirect Method

Using the indirect method, determining the company's net profit on an accrual basis is the starting point and can be easily found in the profit and loss statement. The indirect method looks at the company's net profit, and then adds back noncash expenses, such as depreciation, and not cash revenues, such as sales in credit, into the net income balance.

As noted, the indirect method is only relevant if you account for amounts accrued but which have not yet been realized, such as accounts receivable (money earned but not yet received) and accounts payable (amounts owed but not yet paid).

Below is an example of a cash flow statement using the indirect method.

Sample Cash Flow Statement

Most bookkeeping software tools such as QuickBooks and Xero also help your accountant create cash flow statements for you when the books are closed (usually quarterly or annually). At Finaloop, we create real-time, on-the-go cash flow statements under both methods. This helps our businesses track their cash flows, regardless of the accounting method they decide to use.

Short-Term Liquidity vs Long-Term Solvency

Liquidity measures your company's short-term ability to pay its bills. Solvency is the long-term measure of your ability to keep the company running and profitable over the long-term.

The first part of the cash flow statement usually focuses on liquidity, specifically on operational cash flow (amounts expected to receive or pay out in the upcoming year.)

Solvency is evaluated in terms of debt levels and equity, which are primarily shown in the cash flow from financing section of the cash flow statement. It measures how the company's cash flow can support its long-term liabilities - that is, its ability to serve the interest payments on loans after paying all its operational obligations, and making all necessary investments.

Conclusion

The cash flow statement is an important financial statement as it allows managers, banks, lenders and investors to quickly see how money is coming in and being spent by the company, indicating the company's ability to pay its obligations and stay liquid and solvent.

Finaloop can assist with quick and accurate creation of a cash flow statement for your eCommerce business by extracting information from your banks, credit card providers and third-party applications, connecting everything together in one place to determine your overall cash flow. Your Finaloop dashboard provides you with all your business financial information, and easily creates your cash flow statement and all other financial documents, to help you, your lenders and investors quickly understand your company's financial status, allowing you to make timely and educated business decisions .

The information provided on this website does not, and is not intended to, constitute legal advice. All information, content, and materials available on this site are for general informational purposes only. Readers are advised to consult with their attorney or accountant with any questions or concerns.

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