Back to Basics – Understanding the Cash Flow Statement – Week 3

To reiterate, there are four main types of financial statements: the balance sheet, the income statement, the cash flow statement, and the statement of shareholder’s equity. Balance sheets were our first topic of discussion this month; last week we covered income statements; now it’s on to cash flow statements.

There is a difference between profit — what your company actually makes  — and cash. Profit is the overall money your company earned for a given time period, which, as we discussed in our last blog, is what the income statement tracks. Cash is the money you actually have immediately available to you, which is what the cash flow statement tracks.  It records the inflow (money coming in) and outflow (money going out, e.g., expenses, purchasing, etc.) of cash in your business and how it’s being used. The SEC states, “A cash flow statement shows changes over time rather than absolute dollar amounts at a point in time. It uses and reorders the information from a company’s balance sheet and income statement.”

Now you may be asking yourself why is it useful to have a cash flow statement, or why to bother going over it. For you and your investors, it’s the most informative financial statement there is–for the simple reason that having one of these allows you to pinpoint exactly from whence your cash surplus, or deficit, is coming, giving you the immediate  opportunity to adjust your business as necessary. Or, as financial writer Reem Heakal succinctly put it: it tells you how your company’s cash flow is performing, where your money is coming from, and how it’s being spent. You should review this statement carefully. If you don’t understand what’s going on, pose questions to one who knows.

Generally, there are three different types of activities that cash is involved in and tracked: operating activities, investing activities, and financing activities. Reviews of these show an increase or decrease of your cash over a set period of time. Below is a very, very basic outline of what each of these terms refers to:

Operating Activities

This is the most important of the three activities, documenting where your money goes in the operations of the business. This is where you can follow what happens to your profits as changes occur in accounts receivable, inventory and accounts payable.

Follow these two rules to find the cash:

  • An increase in any asset other than cash has a negative impact on cash and a decrease in any asset other than cash has a positive impact on cash.
  • An increase in any liability has a positive impact on cash and a decrease in any liability has a negative impact on cash.

Investing Activities

Investment activities is as it sounds, monitoring the purchase and sale of permanent assets in your business. The same two rules above also apply to investing activities.

Financing Activities

Financing activities show the changes to cash flow by owner decisions, such as borrowing money, equity capital transactions and dividends paid out to owners. The same two rules above also apply to financing activities.

For more information, check out the SEC’s brochure on A Beginner’s Guide to Financial Statements:

Understanding these three activities together gives you a strong hold over the running of your business, and in combination with your balance sheets and income statements, begin to give you an advantage in whatever field your business exists by illustrating where you have the opportunities to strengthen, contract, or grow your business to your best advantage. Don’t underestimate the power of your financial statements; understanding them fully will give you the tools to give your business its best shot for success.

How about you? Has your cash flow statement revealed opportunities to you that you might otherwise have missed? Opportunities to grow, or to improve cash flow?