Cash Flow Statements Explained

The sole purpose of the cash flow statement is to tell us where the money came during the last 12 months and where it went.

?We don’t get this information from the other 2 financial statements.

?The Income statement (P&L) tells us the profit or loss for the period but does not tell us about money (actual amounts going in and out the bank account).

The balance sheet does provide us with the bank balance at the start of the year (the opening balance) and the bank balance at the year-end (the closing balance) but it does not give us any detail about where money came from or went during the course of the year.

So.. the cash flow statement essentially fills in the blanks for us and tells us the rest of the story.

Accounting statements dictate that we divide the story into 3 parts – operating, investing and financing activities of the business.

Let’s explore each one:

Operating activities

Money in: For selling goods or services to customers.

Money out: As a result of paying for the running of the business – paying for inventory, salaries, supplies, insurance, water, telecoms, electricity, advertising etc..

Investing activities

Money in: For selling non-current assets (machinery, equipment, land & buildings)

Money out: As a result of buying non-current assets (machinery, equipment, land & buildings)

We record investing activities in their own category as:

1. These events happen less frequently and
2. If we do receive money for selling a non-current asset or pay money to buy a non-current asset – this does not tell us anything about how the business has performed operationally and what money has come in from customers or has been spent on running the business.

Financing activities:

Money in: From shareholders and lenders

Money out: To shareholders and lenders

Without the cash flow statement, we'd be lost

Think about it like this:

If our bank balance was 0 at the beginning of the year (we had just started the business) and 100,000 at year end does that mean the business performed well or performed badly?

?Without the cash flow statement and its three categories – we would have know idea.

?We wouldn’t know if that 100,000 cash originated from selling our products, from having sold non-current assets (unrelated to our day to day business) or perhaps we received a loan from a lender for 100,000.

?The cash flow statement would be able to tell us exactly where that money came from.

?Here’s a sample cash flow statement using the direct method, so you can see the layout and the 3 categories. We calculate the net cash flow for each category to make it clear which category was generating/spending the most money.

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You’ve all heard the saying: Cash is king!

The cash flow statement is a crucial statement to understand the health of a business. Cash is the lifeblood of any company and without cash or access to cash, it’s game over!

Best,

Mark

PS - If your non-finance managers struggle to manage their cash and prepare effective budgets, we can help. Visit www.accountingmadeeasy.co or DM me to set up a demo.

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