In this tutorial I'm going to go over the format and components of a simple cash flow statement and give you a nice cash flow statement example.
But before we start, have you heard of this saying?
Cash is king.
This is a common saying in the business world. And it is quite true, because cash is the lifeblood of the business.
Without cash, you can't pay bills, you can't expand the business by purchasing assets. You can't pay employees. As the business owner, you couldn't even pay yourself!
Just as it sounds, the cash flow statement is a statement (report) of flows (both in and out of the business)of cash.
But why do we need the cash flow statement if we've already got the income statement?
The answer is that one could show the most fantastic performance according to the income statement, with huge profits, and yet have nothing remaining in the bank. Your business wouldn't survive very long in that kind of situation.
You may be wondering, "But how could that even occur?"
It could occur if all or most of your sales have been made on credit. And it could occur if additionally you weren't monitoring the cash flows of your business.
In real life this extreme situation would rarely occur, but this example serves to explain that the cash situation of a business is key. And the cash flow statement, which shows us what the business has been doing with its cash - provides vital information.
So yes, cash really is king - in the business world and even in accounting.
The Cash Flow Statement Format
Okay, so before any more explanations, here's the format of the cash flow statement itself (by the way, this is for the direct method of the cash flow statement - for simplicity purposes we won't cover the indirect method here). See further below for explanations...
Notes on the Format Above
Cash can flow in two directions – either coming in to your business or going out. Cash coming in to your business is shown as positive amounts, whereas cash going out from your business are shown as negative amounts (in parentheses).
Note that dividends are cash payouts to people who have bought shares in a company.
Dividends are similar to drawings(in a small business), in that the owner is getting a payout (drawings is the owner of a small business withdrawing some of the cash that he first invested in it).
Also note that proceeds simply means cash received.
Like the rest of the financial statements, the cash flow statement is usually drawn up annually, but can be drawn up more often.
It's important to note that the cash flow statement covers the flows of cash over a period of time (unlike the balance sheet that provides a snapshot of the business on a specific date).
Cash Flow Statement Sections
The statement is divided into four parts. I'll go over each of these below.
1. Cash Flow from Operating Activities
The first part is the cash flows relating to your operations – the core activities of your business.
This includes cash receipts (cash received) from your customers, cash paid to suppliers and employees, interest received or paid and tax paid.
2. Cash Flow from Investing Activities
The second section is the cash flow frominvesting activities.
Investing (in the context of the cash flow statement) means the spending of cash on non-current assets.
For example, one could be spending cash on computer equipment, on vehicles, or even on a building one purchased.
Thus investing activities mainly involves cash outflows for a business.
We also include cash inflows in this section relating to the sale of a non-current asset that we have already invested in. Thus, the cash received this year from selling equipment that was originally bought (invested in) three years ago, would also be included in this section.
As investing activities mainly deal with cash outflows (buying non-current assets), the total of this section is usually a negative.
Purchases of assets are put under two different categories: additions or replacements.
Additions means purchases of additional assets in order to expand the business.
Replacements do not involve expansion but rather refer to an asset being purchased to replace an old or obsolete (no longer used) asset.
3. Cash Flow from Financing Activities
Cash flow from financing activities is the third section.
Financing is the source of the cash that we will be using to invest in non-current assets.
It is where we get cash from.
Thus financing activities mainly involves cash inflows for a business.
We also include cash outflows in this section that relate to financing that we originally obtained. Thus the repayment of a loan (in part or in full) falls under financing activities (as a cash outflow), as the loan served as finance for the business originally.
Similarly, drawings (or dividends for a corporation) may also be placed under this section, although it can also be placed under the operating activities section if the business so chooses.
As financing activities mainly deal with cash inflows (receiving cash from shareholders or lenders), the total of this section is usually a positive for cash flow.
4. Net Increase / Decrease in Cash
The final section comprises the net cash increase or decrease for the period as well as the cash balance at the beginning and end of the period.
Creating a Cash Flow Statement
The cash flow statement would be drawn up from records of one's cash and bank account.