A cash flow statement is a financial report that describes the sources of a company's cash and how that cash was spent over a specified time period. It does not include non-cash items such as depreciation. This makes it useful for determining the short-term viability of a company, particularly its ability to pay bills. Because the management of cash flow is so crucial for businesses and small businesses in particular, most analysts recommend that an entrepreneur study a cash flow statement at least every quarter.
The cash flow statement is similar to the income statement in that it records a company's performance over a specified period of time. The difference between the two is that the income statement also takes into account some non-cash accounting items such as depreciation. The cash flow statement strips away all of this and shows exactly how much actual money the company has generated. Cash flow statements show how companies have performed in managing inflows and outflows of cash. It provides a sharper picture of a company's ability to pay creditors, and finance growth.
It is perfectly possible for a company that is shown to be profitable according to accounting standards to go under if there isn't enough cash on hand to pay bills. Comparing amount of cash generated to outstanding debt, known as the "operating cash flow ratio," illustrates the company's ability to service its loans and interest payments. If a slight drop in a company's quarterly cash flow would jeopardize its ability to make loan payments, that company is in a riskier position than one with less net income but a stronger cash flow level.
Unlike the many ways in which reported earnings can be presented, there is little a company can do to manipulate its cash situation. Barring any outright fraud, the cash flow statement tells the whole story. The company either has cash or it does not. Analysts will look closely at the cash flow statement of any company in order to understand its overall health.
PARTS OF THE CASH FLOW STATEMENT
Cash flow statements classify cash receipts and payments according to whether they stem from operating, investing, or financing activities. A cash flow statement is divided into sections by these same three functional areas within the business:
• Cash from Operations - this is cash generated from day-to-day business operations.
• Cash from Investing - cash used for investing in assets, as well as the proceeds from the sale of other businesses, equipment, or other long-term assets.
• Cash from Financing - cash paid or received from issuing and borrowing of funds. This section also includes dividends paid. (Although it is sometimes listed under cash from operations.)
• Net Increase or Decrease in Cash - increases in cash from previous year will be written normally, and decreases in cash are typically written in (brackets).
Although cash flow statements may vary slightly, they all present data in the four sections listed here.
CLASSIFICATIONS OF CASH RECEIPTS AND PAYMENTS
Cash from Financing
At the beginning of a company's life cycle, a person or group of people come up with an idea for a new company. The initial money comes from the owners or is borrowed by the owners. This is how the new company is "financed." The money that owners put into the company is classified as a financing activity. Generally, any item that would be classified on the balance sheet as either a long-term liability or an equity would be a candidate for classification as a financing activity.
Cash from Investing
The owners or managers of the business use the initial funds to buy equipment or other assets they need to run the business. In other words, they invest it. The purchase of property, plant, equipment, and other productive assets is classified as an investing activity. Sometimes a company has enough cash of its own that it can lend money to another enterprise. This, too, would be classified as an investing activity. Generally, any item that would be classified on the balance sheet as a long-term asset would be a candidate for classification as an investing activity.
Cash from Operations
Now the company can start doing business. It has procured the funds and purchased the equipment and other assets it needs to operate. It starts to sell merchandise or services and make payments for rent, supplies, taxes, and all of the other costs of doing business. All of the cash inflows and outflows associated with doing the work for which the company was established would be classified as an operating activity. In general, if an activity appears on the company's income statement, it is a candidate for the operating section of the cash flow statement.
Methods of Preparing the Cash Flow Statement
In November 1987, the Financial Accounting Standards Board (FASB) issued a "Statement of Financial Accounting Standards" which required businesses to issue a statement of cash flow rather than a statement of changes in financial position. There are two methods for preparing and presenting this statement, the direct method and the indirect method. The FASB encourages, but does not require, the use of the direct method for reporting. The two methods of reporting affect the presentation of the operating section only. The investing and financing sections are presented in the same way regardless of presentation methods.
The direct method, also called the income statement method, reports major classes of operating cash receipts and payments. Using this method of preparing a cash statement starts with money received and then subtracts money spent, to calculate net cash flow. Depreciation is excluded altogether because, although it is an expense that affects net profits, it is not money spent or received.
This method, also called the reconciliation method, focuses on net income and the net cash flow from operations. Using this method one starts with net income, adds back depreciation, then calculates changes in balance sheet items. The end result is the same net cash flow produced by the direct method. The indirect method adds depreciation into the equation because it started with net profits, from which depreciation was subtracted as an expense. Regardless of whether the direct or the indirect method is used, the operating section of the cash flow statement ends with net cash provided (used) by operating activities. This is the most important line item on the cash flow statement. A company has to generate enough cash from operations to sustain its business activity. If a company continually needs to borrow or obtain additional investor capitalization to survive, the company's long-term existence is in jeopardy.
ONLINE CASH FLOW WORKSHEETS
Achieving a positive cash flow does not come by chance. You have to work at it. You need to analyze and manage your cash flow to more effectively control the inflow and outflow of cash. The U.S. Small Business Administration recommends undertaking cash flow analysis to make sure you have enough cash each month to cover your obligations in the coming month. The SBA has a free cash flow worksheet you can use. In addition, most accounting software packages geared to small or mid-sized businesses – such as Quickbooks will help you produce a cash flow statement. There are also other websites offering free templates, including Winsmark Business Solutions and Office Depot.
FINANCING AND INVESTING SECTIONS
The cash flows, in and out, resulting from financing and investing activities are listed in the same way whether the direct or indirect method of presentation is employed.
Cash Flows from Investing
The major line items in this section of the cash flow statement are as follows:
• Capital Expenditures. This figure represents money spent on items that last a long time such as property, plant, and equipment. When capital spending increases, it often means the company is expanding.
• Investment Proceeds. Companies will often take some of their excess cash and invest it in an effort to get a better return than they could in a savings account or money market fund. This figure shows how much the company has made or lost on these investments.
• Purchases or Sales of Businesses. This figure includes any money the company made from buying or selling subsidiary businesses and will sometimes appear in the cash flows from operating activities section, rather than here. Cash Flows from Financing The major line items in this section of the cash flow statement include such things as:
• Dividends Paid. This figure is the total dollar amount the company paid out in dividends over the specified time period.
• Issuance/Purchase of Common Stock. This is an important number because it indicates how a company is financing its activities. New, rapidly growing companies will often issue new stock and dilutes the value of existing shares in so doing. This practice does, however, give a company cash for expansion. Later, when the company is more established it will be in a position to buy back its own stock and in this way increase the value of existing shares.
• Issuance/Repayments of Debt. This number tells you whether the company has borrowed money during the period or repaid money it previously borrowed. Borrowing is the main alternative to issuing stock as a way for companies to raise capital.
The cash flow statement is the newest of the three fundamental financial statements prepared by most companies and required to be filed with the Securities and Exchange Commission by all publicly traded companies. Most of the components it presents are also reported, although often in a different format, in one of the other statements, either the Income Statement or the Balance Sheet. Nonetheless, it offers the manager, investor, lender, and supplier of a company a view into how it is doing in meeting its short-term obligations, regardless of whether or not the company is generating income.
Brahmasrene, Tantatape, and C. David Strupeck, Donna Whitten. "Examining Preferences in Cash Flow Statement Format." The CPA Journal. October 2004. Hey-Cunningham, David. Financial Statements Demystified. Allen & Unwin, 2002. O'Connor, Tricia. "The Formula for Determining Cash Flow." Denver Business Journal. 2 June 2000. Taulli, Tom. The Edgar Online Guide to Decoding Financial Statements. J. Ross Publishing, 2004. "Ten Ways to Improve Small Business Cash Flow." Journal of Accountancy. March 2000. "Understanding Cash Flow," Financial Management Series, U.S. Small Business Administration Copyright © 2009 Mansueto Ventures LLC. All rights reserved. Inc.com, 7 World Trade Center, New York, NY 10007-2195.
This essay covers important topics related to the management of cash flow within companies. Cash is defined as currency in corporate accounts, short term investments or commercial paper that's easily convertible to cash. A steady cash flow enables a business to pay its employees and vendors and to invest in new projects and opportunities. Companies face many risks associated with running out of cash; without a ready supply of cash, businesses cannot repay loans, provide goods and services to customers or invest in future growth opportunities. Businesses are required to file a statement of cash flow as outlined by the Financial Accounting Standard's Board Statement of Cash Flow (FASB statement 95). Trends in cash management are evolving to meet the opportunities offered by global markets and to mitigate risks associated with cash shortfalls. Emerging topics in cash management include more active methods of forecasting company cash flow. Other factors that will impact cash management forecasting include: Improved technology, centralization of corporate forecasting, tighter regulatory controls, and new statistical techniques for cash flow analysis.
Keywords Cash Flow Statement; Cash Management Forecasting; Cash; FABS Statement 95; Financing Cash Flow; Free Cash Flow (FCF); Internal Rate of Return (IRR); Investment Cash Flow; Net Present Value; Operation Cash Flow; Present Value; Regression Analysis
Finance: Cash Flow
Without the proper accounting of cash flow intake and outflow over time, businesses would be operating at great risk of coming up short on liquid capital. Having a tally of cash on-hand, what's coming in (accounts receivable) and what's going out (accounts payable), allows a business to meet expenses and plan future operations. Depending upon the size and complexity of the business operation, a firm is likely to want to project future cash flow in the short-term (12 months) or long-term (5-10 years). Small business with limited access to credit may find that they must forecast cash flow needs for a number of weeks or months. In all cases, cash flow management requires planning and projections into the future and should take into account reasonable risks that might cause a company to fall short of cash.
History of Business Cash Flow Reporting
Originally, businesses were required to file a statement of changes in financial position, or a funds statement. In 1961, Accounting Research Study No. 2, sponsored by the American Institute of Certified Public Accountants (AICPA), recommended that a funds statement be included with the income statement and balance sheet in annual reports to shareholders.
By 1963, the Accounting Principles Board (APB) had issued its Opinion No. 3 as a guideline to help with preparation of the funds statement. While the funds statement was not mandatory for many, businesses saw its value and began to use it regularly. In 1971, Opinion No. 19 (Reporting Changes in Financial Position), also issued by the APB designated the funds statement as one of the three primary financial documents required in annual reports to shareholders. The APB also said a funds statement must be covered by the auditor's report, but did not specify a particular format for the funds statement.
That flexibility came to an end in late 1987, with the Financial Accounting Standards Board's (FASB) issuance of Statement No. 95, which called for a statement of cash flows to replace the more general funds statement. Additionally, the FASB, in an effort to help investors and creditors better predict future cash flow, specified a universal statement format that highlighted cash flow from operating, investing, and financing activities. This format is still used today (Managing Your Cash Flow, 2005).
Cash flow statements provide essential information to company owners, shareholders and investors and provide an overview of the status of cash flow at a given point in time. Cash flow management is an ongoing process that ties the forecasting of cash flow to strategic goals and objectives of an organization.
This article outlines some of the most common strategies, challenges and issues related to managing cash flow. Issues and challenges include: Maintaining good customer and vendor relations while managing accounts payable and receivable, and paying close attention to the time lag between cash inflows and outflows.
The newest trends in cash management forecasting are also covered in detail. Current methods of forecasting cash flow typically involve the use of regression techniques which don't take into account many business operational variables. This essay details some of the current trends in cash flow forecasting that involve improved computer applications, new statistical methods, the centralization of the forecasting function and other significant developments.
FASB Statement 95
FASB Statement 95 Statement of Cash Flows governs the format of a business's reporting of cash flow. Statement 95 encourages enterprises to report cash flows from operating activities directly by showing major classes of operating cash receipts and payments (the direct method). Enterprises that choose not to show operating cash receipts and payments are required to report the same amount of net cash flow from operating activities indirectly by adjusting net income to reconcile it to net cash flow from operating activities (the indirect or reconciliation method) (FASB, 2007).
The following are cash flow measurements required by the FASB:
- Cash Flow Statements: The cash flow statement acts as a kind of corporate checkbook that reconciles the other two statements. Simply put, the cash flow statement records the company's cash transactions (the inflows and outflows) during the given period.
- Cash Flow from Operating Expenses: Measures the cash used or provided by a company's normal operations. It shows the company's ability to generate consistently positive cash flow from operations. Think of "normal operations" as the core business of the company.
- Cash Flows from Investing Activities: Lists all the cash used or provided by the purchase and sales of income-producing assets.
- Cash Flows from Financing Activities: Measures the flow of cash between a firm and its owners and creditors. Negative numbers can mean the company is servicing debt but can also mean the company is making dividend payments and stock repurchases (Essentials of Cash Flow, 2005).
Cash flow from investment and financing activities are fairly straightforward as outlined by Statement 95. However, Statement 95 allows businesses to report using one of two different methods when it comes to reporting cash flows generated or consumed by operations: The direct method and the indirect method.
- The direct method reports inflows of cash (e.g., from sales) and cash outflows for payment of expenses (e.g., purchases of inventory).
- The indirect method which begins with the net income number, a mixture of cash (e.g., cash proceeds from sales) and non-cash components (e.g., depreciation) and removes non-cash or accrual items, then adjusts for the cash effects of transactions not yet reflected in the income statement (e.g., cash payments for inventory not yet sold).
However, only the direct method reports actual sources and amounts of cash inflows and outflows; the information investors need to understand to evaluate the liquidity, solvency, and long-term viability of a company.
Although the standards generally allow managers to select either method for reporting cash flows, the overwhelming majority have chosen to use the indirect method; the approach that provides the least useful information for investment decisions (Direct- versus Indirect-Method Reporting for Cash Flows, 2007).
Current Challenges to Companies Managing Cash Flow
According to Brian Hamilton, CEO of Sageworks, "Businesses don't fail because they are unprofitable; they fail because they get crushed on the accounts receivable side" (Feldman, 2005).
Companies that run short on cash have to use credit cards or lines of credit to fund operations and pay bills. Lack of cash can cause damage to relationships with vendors and banks result in missed market opportunities, and an overall hit to a company's reputation. Running short of cash can result from poor forecasting, unforeseen risks and poor internal management of cash flow. One of the biggest reasons that businesses run short on cash has to do with unrealistic expectations about how quickly cash will come in the door.
Companies need to be realistic about the length of time it will take to get paid — if one assumes payment in 30 days and it takes 60 days to get the cash, then adjustments to "cash in hand" figures need to be made. Corporations are becoming slower to pay vendors; companies want to make more of their cash which means that they are holding on to it longer. Many businesses are also revising their payables to 45-60 days instead of the previous standard of 30 days (Feldman, 2005).
The lag between the time you have to pay suppliers and employees and the time you collect from customers is the problem. The solution is cash flow management and the idea is to delay outlays of cash as long as possible, while encouraging those who owe you to pay quickly.
Creating a cash flow projection is a preemptive action that is meant to alert a business owner or management to the possibility of a cash crunch before it strikes. Projecting cash flow is not a difficult undertaking, but it does require that accurate and timely information regarding payables and receivables be documented. The following information needs to be considered:
- Customer payment history;
- Assessment of upcoming expenditures;...