A guide for small businesses
It is important for a business to run and analyze a Cash Flow Statement periodically. The primary purpose of the report is to show the source of the inflows and outflows of the company’s operations and to provide a depiction of how well the company is managing its cash. Additionally, the Cash Flow Statement will classify the inflows and outflows from the company’s operating, investing and financing activities. The Cash Flow Statement essentially takes items from the Profit and Loss Statement, which is on an accrual basis, and converts them to a cash basis. It also deducts non-cash items, such as depreciation, from the Profit and Loss Statement.
Showing how a company is managing its cash will be beneficial in many ways. It can help a company obtain investors for a new operation they are planning to launch or help them obtain debt from creditors.
Operating activities
The cash items that would be listed under operating activities would be cash inflows and outflows for operating the business. Examples of such items would be revenue inflows from selling a product and payment outflows to suppliers and employees. Other items would be paying for rent, taxes and other expenses for doing business.
Investing activities
Investing activities would include purchasing long term assets to run the business. Such examples would be purchasing equipment or a new facility. Companies may also lend loans to other entities in which they would receive interest and principal payments in return. This type of transaction would be listed under investing activities. Other items would be buying and selling certain investments such as stocks, bonds and mutual funds.
Financing activities
The third item on the Cash Flow Statement is associated with cash inflows and outflows from financing activities. Financing activities are related to borrowing funds, repaying loans to creditors, repurchasing stock and paying dividends.
At the end of the Cash Flow Statement, the company’s beginning and ending cash will be listed. If the Cash Flow Statement was done correctly, the beginning cash plus the operating, investing and financing activity will equal to the ending cash on the books.
Analyzing the Profit and Loss Statement only for profitability will not provide a complete picture of a company’s financial health. A company may have high profits but may have significant debt on the books that they aren’t paying down effectively or may not have enough cash on hand to pay their bills. The only way to obtain a clear understanding of a company’s true financial health is to analyze a Cash Flow Statement along with a Profit and Loss Statement.
By: Andrea Tupper
