The statement of cash flows is one of the most useful financial statements a business can utilize, yet many companies prepare only the standard balance sheet and income statement. The statement of cash flows provides information about a company's gross receipts and gross payments for a specific period of time. Whether updated on an annual, quarterly or monthly basis, this document tracks both cash and cash equivalents that are amassed from ongoing operations and external investments, as well as those used for business expenditures.
"This document provides answers to the questions of 'Where did the money go?' or 'My company is profitable – so why isn't there any cash?'"
A cash flow statement does not track a business' net income or forecasted earnings – such as outstanding payments or recently acquired contracts that are not yet billed. Instead, this document provides insight into how available cash funds are being used by the business. The statement of cash flows provides answers to the important questions of "Where did the money go?" or "My company is profitable – so why isn't there any cash?"
This financial statement is also helpful for investors, as it indicates how well a company is managing its cash and its growth. If the business is bringing in more cash than it is spending, this means the business is more likely to grow or decrease its debt, which makes its stocks more valuable. Publicly traded companies are also required by law to provide a statement of cash flows to investors.
Elements of a statement of cash flows
A statement of cash flows can be used to not only record, but also to categorize a business' cash revenues and expenditures over a pre-determined period. The document is divided into these elements:
- Operating activities
- Investing activities
- Financing activities
- Supplemental disclosure
All cash receipts and payments fall into the category of operating, investing or financing activities. Operating activities will directly reflect how the company operates on a regular basis – including how it made money and how this money was spent. Revenue collected from customers and payments made to suppliers would fall under operating activities. This portion of the cash flow statement can also provide insight into the company's ability to collect on its accounts receivable. If the statement of cash flow shows a significant decrease in funds coming in, the business may need to make changes to its collection policy.
"The cash flow statement may serve as a warning that the company is over-investing."
The investing-activities portion of the statement reflects how a business is preparing for its future growth. The purchase or sale of long-term assets such as land, buildings or equipment would be considered an investing activity. Also, loans made to others, insurance proceeds and the sale or purchase of stocks, bonds or securities would be recorded here. This portion of the document helps a company to forecast its future costs or revenues, but can also serve as a warning if too much investing is directing funds away from necessary operating expenses.
Finally, financing activities are recorded to show changes in the company's liability, equity or other matters that reflect the company's strategy for its financial management. Proceeds from the issuance of the company's own stocks or bonds, and payments made on a debt or a loan would be recorded under financial activities. Any changes in the company's capital or debt should be reflected in this portion of the document.
Additionally, a statement of cash flows should also disclose any investing and financing activities that would affect the company's assets or liabilities but did not result in cash receipts or payments. These activities should be included under a supplemental disclosure.
The importance of the statement of cash flows
In addition to providing direct insight into how the business is using its funds, the statement of cash flows can speak to the company's underlying strategies for growth. The statement can serve as a warning that a company is relying too heavily on bank financing, is making too many loans to others or is investing too heavily. Often, this document will be able to provide insight into these factors before they are reflected in the business's net income. Alternatively, the statement of cash flows can be used to attract new investors by demonstrating the company's financial health and sound management.
The cash flow statement allows businesses to make more informed decisions about their daily operations and is a valuable tool for businesses of all sizes. For more information on preparing a statement of cash flows, contact LaPorte's accounting services professionals for additional guidance on how to develop and use this important financial statement.