Accounting / Bookkeeping Basics: Understanding The Cash Flow Statement

The Cash Flow Statement

The cash flow statement refers to a financial report that states the amount of cash earned and spent in a company. It reveals how cash is moving into and moving out of a business organization. It is also called the statement of cash flow; it is one of the primary financial statements used by financial analysts.
The cash flow statement reflects and evaluates how an organization manages its cash. It reveals how the performance of the balance sheet accounts and income statements influence the flow of cash. Accountants, shareholders, potential investors, analysts, employees, creditors, and contractors are the people interested in the statement of cash flow of an organization.
This financial statement is specifically designed to offer the necessary information on a business's solvency and liquidity. The cash flow statement is primarily concerned about how cash is generated and spent.

The Main Components of the Cash Flow Statement
The cash flow statement is divided into three major components, which are:
The flow of cash from operating activities
The flow of cash from investment
The flow of cash from financing activities
The cash flow statement sometimes adds a disclosure of non-cash activities as part of the components according to the Generally Accepted Accounting Principles. The cash flow statement is different from the balance sheet account and the income statement.

Cash Flow from Operating Activities
Operating activities involve the manufacturing of goods, sales of goods, receiving payments from customers, and delivering the products of a company. These are activities that generate revenue for a business. These activities have to deal with purchases, sales, and expenses that will generate revenue for the business.
These expenses can be advertising, shipping the goods, purchasing raw materials, and building inventory. Cash flow from operating activities is the cash generated from the income of a company; it excludes costs related to investment in securities or investment on capital items.
The flow of cash from operating activities can be derived by using the direct and indirect method. The direct method reflects how the in-flow and out-flow of cash in the business affect all liability and  current asset account. The indirect method reflects how profit is reconciled with cash flow.

Cash Flow from Investing Activities
Investing activities include loans given to suppliers, the sales of assets, purchases of assets, payments linked to acquisitions and mergers, and dividends received from another organization. Cash flow from investment refers to activities that are linked to the sale or purchase of capital assets.
Investing activities refer to activities that generate gain over a long-term period. They lead to changes in non-current assets like equipment, government bonds, investment in shares, etc. Investing activities have nothing to do with cash from external investors like shareholders or bondholders.
For instance, if a company pays out a dividend to its investors, this type of activity is not an investing activity; it is called a financing activity. Examples of investment activities include cash generated from selling an asset, cash spent on the purchase of an asset, cash generated as a result of the merger, cash generated from another company's acquisition.

Cash Flow from Financing Activities
Financing activities refer to events that lead to changes in the composition and size of the capital. Financing activities involve taking out loans, issuance of shares, paying dividends, etc. When a company extends credit to a customer, it is not a financial activity; it is an investing activity.
Cash flow related to repaying loans, borrowing, and issuing of shares is classified as cash flow from financing activities. Financing cash flow reveals the sale or purchase of stock in a company.

How to Calculate Cash Flow
In accounting, cash flow can be calculated by adjusting the net income. The working cash flow is revealed in the statement of cash flow. The working cash flow reflects the in-flow of cash during a particular period. There are two methods of calculating operating cash flow. These methods are direct and indirect.
The direct method derives information from the income statement by making use of cash disbursements and cash receipts. In the direct method, different kinds of payment received and made through cash are added. You can calculate these payments and receipts by making use of the balances of different business accounts.

In the indirect method, working cash flow is calculated by deriving the net income from the income statement of an organization. Because the income statement of an organization is always made on an accrual basis, income is not recorded when it is received; it is recorded when it is earned. The indirect method is not a straightforward method of calculating operating cash flow.

The Importance of Cash Flow Statements
Investors are always concerned about the cash flow of an organization. Positive cash flow is a good sign for investors because this shows that the organization generates cash from its day-to-day operations. Working cash flow can give a clear picture of an organization's profitability.
The purpose of preparing a statement of cash flow is to evaluate the sources of cash and how cash is utilized in a company over a particular period. The cash flow statement is one of the most important financial statements in accounting. Investors depend on this financial statement for making decisions because of its transparency.
The statement of cash flow helps to determine the solvency and liquidity of a business. It provides the necessary details for accessing a company's liabilities, assets, and equity. With the cash flow statement, businesses can determine the trends of their performance. This financial statement also predicts the timing and amount of cash flows in the future.
A business can only be successful if it has enough cash. Cash is needed to make business transactions like paying expenses, paying taxes, purchasing assets, and paying loans. With a cash flow statement, a business can determine the amount of cash available and how cash is generated and spent daily.
A business that lacks enough cash cannot make business transactions, and with time will go bankrupt. Without cash in a business, such businesses will need to borrow money to make some business transactions; this is not healthy for a business. The cash flow is useful in businesses and big organizations.

Also read:

Accounting / Bookkeeping Basics: Understanding Balance Sheets

Accounting / Bookkeeping Basics: Understanding Income Statements