In this tutorial I'm going to go over the format and components of a simple cash flow statement and give you a detailed example (further below).
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 of cash - both in and out of the business.
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.
Okay, so before anything else, here's the format of the cash flow statement itself (see further below for explanations):
The statement is divided into four components. I'll go over each of these below.
The first component 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 and for general operating expenses, interest received or paid and tax paid.
The second component is the cash flow from investing 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.
Cash flow from financing activities is the third component.
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.
The final section of the statement comprises the net cash increase or decrease for the period as well as the cash balance at the beginning and end of the period.
The cash flow statement can be drawn up directly from records of one's cash and bank account.
Here is the bank T-account for the sample business we've been using throughout our tutorials, George's Catering:
The cash flow statement for George’s Catering would look as follows:
Note that the "cash at the beginning of the period" amounted to $0, as this was the first year in which George's Catering was operating. Since most businesses are already up and running for many years, there would usually be an opening cash balance.
Remember, the cash flow statement shows flows of cash, not income and expenses.
Whereas income could be on cash or on credit, cash receipts from customers would only be cash.
Our accounting equation for George’s Catering looked as follows at the end of the period:
The closing balance of the bank account corresponds to the answer we calculated in our cash flow statement.
These budgeted figures would be drawn up based on actual figures from past years, but taking into account any expected future changes in cash flows.
The budgeted figures for the cash inflows and outflows (and the way these figures were obtained) would be explained or justified in additional notes to this statement.
By the way, and just as a final note, do not confuse the cash flow statement with a cash budget. These are two completely different things.
Before you start, I would recommend to time yourself to make sure that you not only get the questions right but are completing them at the right speed.
Beginner --> Intermediate
Important: The solution sheet on the following page only shows the solutions and not whether you got each of the questions right or wrong. So before you start, get yourself a piece of paper and a pen to write down your answers. Once you're done with the quiz and writing down your answers, click the Check Your Answers button at the bottom and you'll be taken to our page of solutions.
That's all folks! Hope you enjoyed my cash flow statement example and explanations!
Head on over to the next lesson where you'll learn all about other accounting reports you may come across, such as an asset register, a debtor's analysis, and more.
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