Successful businesses need to have adequate access to cash. Companies need to fund their daily operations and expenses, pay taxes and loans, and purchase new assets. A cash flow statement is fundamental to every business as it helps determine whether the company can support itself with enough cash.
Investopedia defines a cash flow statement as a financial statement that summarizes the cash and cash equivalents entering and leaving a company.
The cash flow statement tracks how well a company manages its cash and identifies how well a company can generate some money to pay any financial obligations and fund its operating costs. It complements the balance sheet and income statement and is a mandatory part of a company’s financial reports.
When a business no longer has enough cash flow to support its needs, at some point, it will be unable to sustain itself, which is why cash flow statements and learning how to prepare them correctly is crucial.
Let’s explore some key tips and tricks to preparing a reliable cash flow statement for your business.
Use the Right Structure
A cash flow statement primarily provides a better understanding of how an organization’s operation runs, including knowing the source of cash and its relative expenditures.
To create the right structure for your cash flow statement, it is essential to know what it is for and its reason.
For example, investors turn to cash flow statements to make better sense of a company’s financial health. In contrast, creditors use it to understand how much cash is available to continue funding its operating costs or pay off its debts.
Understand the Components of a Cash Flow Statement
Below are the essential components of the cash flow statement.
Cash from operating activities
Operating activities on the cash flow statement refer to how much cash is generated from its products, services, and business activities.
This can include all other changes made in cash, accounts receivable, depreciation, inventory, and accounts payable. These can highlight operating activities such as rent and supplier payments, interest and income tax payments, salary and wages, and all other operating costs and expenses.
Cash from investing activities
Investing activities are all sources and uses of cash made from a company’s investments such as asset purchases, vendor loans, or merger and payment acquisitions. Any changes to equipment, assets, and investments will be listed here. Cash-out items refer to any equipment or short-term assets bought by the company, and cash in items is related to money made from investing.
Cash from financing activities
These can refer to cash coming from investors and banks and those paid to shareholders. Stock repurchase payments, debt payments, and dividend payments are added under this category.
Know the Difference Between Cash Flow Statements, Income Statements, and Balance Sheets
Companies should learn to understand how a cash flow statement is different from income statements and balance sheets. It should not include incoming and outgoing cash that is on credit. Cash should not be considered the same as net income. Although income statements and balance sheets include cash sales and sales made on credit, do not add this in cash flow statements.
Learn Your Ratios
Learning how the figures correlate in your cash flow statement is crucial to understanding it. For instance, you’ll notice the net cash flow at the end of each activity.
- Net cash flow– generated from operating activities is the company’s cash at the end of the period.
- Free cash flow– refers to the amount of cash available that can be used to invest or repay the financing, which is derived by adding net cash from operations.
- Dividend payout ratio– refers to the free cash flow given to shareholders. Calculate by dividing the free cash flow by dividends paid.
- Free Cash flow margin– refers to the amount per dollar that is being converted to free cash. You can get this by dividing free cash flow by revenues.
- Free cash to earnings ratio– refers to the percentage of free cash garnered from net income. You can get this by dividing free cash flow by net income.
It is also worth noting that it takes over a year’s worth of cash flow statements to get an accurate picture of company performance. A company’s assets may be increasing but show low cash flow in a given year. Companies who want to make the right investment decisions should look into 2–3 years’ worth of cash flow statements to have a more unobstructed view of how well they are performing financially.
The Bottom Line
Cash flow statements help companies measure their long-term profitability and performance regardless of the current market conditions. Therefore, companies need to structure it correctly to continue to use it to predict cash flow and liquidity. It also aids them in all things specific to financial reporting and financial consolidation.
On the other hand, investors will turn to it to better understand how a company runs its operations, helping them understand its overall financial health and investment viability.
Investing in a financial reporting and analysis tool that promotes cash flow analysis can help businesses safeguard their financial well-being. If you’re looking for an agile tool that enables your business to better track its cash flow statements and other vital reports such as balance sheet, income statement, profit and loss statement, Performance Canvas can help.
With Performance Canvas, you get all these reports out of the box, plus you get the ability to create custom reports easily from scratch. You can even create advanced or highly sophisticated reports using the Performance Canvas built-in business rules engine and its modern drag and drop report wizard.
Find out more about Performance Canvas’s packages to fit the growing needs of your businesses.