The statement of cash flows explained!
6 minute read
Cash is the oxygen your business needs to exist and grow. However, understanding the movement of your cash can often be tricky, especially when you’re a new business owner.
This is where the statement of cash flows comes in as a valuable financial statement for your business.
Ready to find out more about what the statement of cash flow is and the benefits it can provide to your business? Keep on reading below!
The statement of cash flows
Essentially, the statement of cash flows shows how much cash your business has spent and earned within a specific time period, as well as its key drivers.
So, what does a typical statement of cash flows look like?
Let’s use the example of an ice cream retailer to help us visualize and understand the statement of cash flows.
Here’s an example of an ice cream retailer to help visualize and understand the statement of cash flows:
From what we can see, the business has had a positive net cash flow of $30,000 for the year ending 31 December 2020.
Why you should love the statement of cash flows
If you hadn’t guessed by now, the statement of cash flows provides useful insight into where your precious business cash has been used and sourced from.
If you’re burning through your cash faster than you anticipated, then reviewing your statement of cash flows will help you to identify where you have overspent so that you can change tactics in the future.
This statement accompanies the Statement of Profit and Loss and the Balance Sheet as one of the 3 key financial statements that, together, give you an excellent insight into your business’ financial position and profitability.
Now let’s walk through the key elements of the statement of cash flows so it’s clear where our cash has come from.
What the statement of cash flows comprises of
Let’s go back to our favourite ice cream business and look at the structure of their statement of cash flows. The statement of cash flows identifies separate cash flows coming from:
- Operating activities. This is the cash coming from the main course of business. For example, selling ice cream, paying staff wages, and paying rent for the premises.
- Investment activities. This is the cash coming from investing in new assets for the business, or investing excess cash in shares, for example.
- Financing activities. This is the cash coming from the sources of finance, most likely in the form of a loan from the bank or an equity injection from shareholders. It can also include dividends paid to shareholders.
- Net income. Simply put – this is their profit, and you will be able to agree on this figure of your profit in your statement of profit and loss.
4 steps to reading your statement of cash flows
We know that profit doesn’t always equal to cash – so we can view the statement of cash flows as being structured as a series of steps that gradually adjust our profit or loss to equal the cash inflow or outflow we’ve seen in that period.
This provides further insight into where your cash has come from and gone to. Here are the 4 steps on how to understand this.
Step 1: Adjustments for non-cash items
A prime example of a “non-cash item” is depreciation. This is when the value of an asset on the balance sheet is reduced over the years.
A depreciation charge is included in profit, but no actual cash changes hands in this process, so it needs to be added back.
Step 2: Changes in operating assets & liabilities
In this step, we look at the balance sheet to identify if we have any outstanding receipts from customers or expected payments to suppliers.
This would mean that some revenues and expenses in our profit figure have not been settled in cash yet, so we would need to add them back.
An example of this is a supplier providing the ice cream store seven days to pay for a shipment of ice cream received. The expense has been incurred because they have the goods, but the cash hasn’t left the business yet.
This is the impact of accrual accounting.
Step 3: Sale and purchase of fixed assets
When we invest in fixed assets to support the running of our business, we do not record this as an expense in our profit and loss. Instead, it is recognized in the balance sheet as an asset, or an item we own.
This means that the cash impact of buying the asset hasn’t been captured in profit – and we would have to add it back in this step.
In this case, the ice cream store has decided to purchase a new ice cream van for $20,000 so that they can boost their sales by accessing more locations.
Step 4: Proceeds from long-term loans
This refers to money from sources of finance. In this case, it would be from the bank that provided a loan of $20,000 so that the ice cream business could buy their van.
This loan sits in the balance sheet and not in the profit – so we would thus have to add it back to profit in this step.
In reality, there are a whole lot of steps that you might take to align your profit with cash – but for starters, those would be the main key ones.
And there you have it! That was a quick rundown of the essential components of the statement of cash flows and the key things to take note of. Hopefully, you now have a better understanding of why this financial statement is so useful, and why so many business owners love it! While you’re at it, here are 10 useful tips for excellent financial management.