The Cash Flow Statement provides a comprehensive view of a company's financial performance. It is important for assessing a company's liquidity, financial health, and its ability to meet its short-term and long-term obligations. The article talks about cash flow statement and its types. You will also learn how to calculate cash flow statements for any business through examples.
To guarantee the proper functioning of a company, it is essential to maintain an optimal level of liquidity, take care of the cash flow issue and constantly analyze it to cover its operations and face unforeseen events. Maintaining a healthy cash flow will allow you to make forecasts to avoid emergency solutions, such as acquiring unplanned financing to resolve a pressing situation. The article focuses on the cash flow statement and how to calculate it.
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- What is a Cash Flow Statement?
- Methods for Calculating Cash Flow Statements
- Objectives of the Cash Flow Statement
- Classification of Cash Flows
- Advantages of Generating a Cash Flow Statement
- How to Generate Cash Flow Statements?
- Example of A Cash Flow Statement
What is a Cash Flow Statement?
A cash flow statement is a basic financial statement that reports on the variations and movements of cash and its equivalents in a given period. It shows the cash generated and spent in the company’s operating, investing, and financing activities.
What information does the cash flow statement show us?
The cash flow statement shows the company’s cash generated and used during a specific quarter, year, or another period. In this way, the report links the balance sheet and the income statement, showing how net income or loss is transformed into the net change in cash. In turn, the net change in treasury determines the amount of cash available on the balance sheet to pay obligations and return value to shareholders through dividends or share buybacks.
Methods for Calculating Cash Flow Statements
To formulate the cash flow statement, two methods are used, which are as follows:
Direct Method: It is formulated by ordering the receipts and payments based on the main categories to which they belong. This method presents the magnitudes derived from the categories by their gross amount.
Indirect Method: It is formulated based on the utility shown by the income statement and then refines it with reconciling items until reaching the adequate balance in the books. This method is more complex in practice and less used since some reconciling items do not represent actual cash movements, although they somehow affect the company’s ability to make payments.
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Objectives of the Cash Flow Statement
The most essential cash flow statement objectives are as follows:
- To provide timely information to management for decision-making that helps the company’s operations.
- To offer information about the items and activities in which the available cash has been spent.
- To report past cash flows to generate forecasts.
- To determine the company’s ability to meet its obligations to third parties and shareholders.
- To help make decisions about short-term investments when there is excess cash available.
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Classification of Cash Flows
Cash flows can be divided based on the following activities:
Operational activities derive from cash movements, originating from producing and supplying goods or services. These transactions transform the cash flow each time customers pay, suppliers or creditors are paid, employee salaries are paid, or taxes are paid, among other movements that generate operations that generate cash flows.
Operational business activities include –
- Receipts from the sale of goods and/or services
- Interest payments
- Income tax payments
- Employee salaries
- Payments to suppliers for goods or services used in production
- Rent payment
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Investing activity includes cash flows associated with long-term assets. These cash flows originated from investment activities that do not derive from cash equivalents, where financial resources are used in fixed assets or financing through a company loan. These flows will reflect the need for the company to invest in fixed assets.
Investing activities include –
- Cash flows associated with buy or sale of an asset
- Investing in FDs, mutual funds, and stocks
- Payments related to mergers and acquisitions
- Other non-current or financial assets
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Long-term liabilities and equity form this activity. An increase in long-term loans or the sale of shares leads to money inflow, a decrease in liabilities, and the distribution of dividends to shareholders.
These cash flows derive from obtaining financial resources, which can occur through capital contributions or third-party loan sources. Finally, these flows reflect the capacity of the self-financing company and, on the other hand, the impact that the payment of past debts can cause, such as the payment of bonds or other instruments that affect financing activities.
Financing activities include –
- Borrowing and repayment of loans
- Raising capital in the form of equity
- Issuing bonds to raise capital
- Paying dividends
Advantages of Generating a Cash Flow Statement
Your statement of cash flows also offers you these advantages:
Measure the Liquidity of Your Business
For your business to run efficiently, you need cash on hand. The cash flow statement measures how effectively you can operate at any given time.
Compare Your Business with the Competition
If your business is relatively new and you need a track record of how much cash you need, it is helpful to compare your statement of cash flows with businesses that are similar in size and type of business. If your status differs significantly from similar businesses, take that as a red flag.
Determine if You Need a Business Loan
Knowing whether or not to apply for a business loan can be difficult, but your cash flow status makes it easier to make this decision. By knowing how much cash you need relative to how much you receive and spend, you’ll know if you need more cash. If so, then getting a business loan could be the right move.
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How to Generate Cash Flow Statements?
To generate cash flow statements, follow the below steps –
1. Determine the Initial Balance
To prepare a cash flow statement, you need to determine the initial or starting balance of cash and cash equivalents from the income statement of the given period.
2. Calculate Cash Flow from Operating Activities
Calculating cash flow from operational activities will help you learn how much a company generates from its operations. This can be calculated either by direct or indirect methods. Both methods will generate the same result, but the process differs. Choose the method that suits you. Most businesses prefer the indirect method, which is faster and closely linked to the balance sheet.
3. Calculate Cash Flow from Investing Activities
The second step is to calculate cash flows from investing activities. This step covers cash flows related to buying and selling assets like property, facilities, and equipment. This step calculates activities involving free cash and not debt.
4. Calculate Cash Flow from Financing Activity
The third step of generating a cash flow statement includes examining cash inflows and outflows emerging from financing activities such as debt and equity financing, raising cash, and paying back debts to investors and creditors.
5. Determine the Final Balance
The resultant cash flow statement generation accounts for cash flows generated from the above-discussed business activities, and the final balance can be determined for a given period.
The final value reflects the total cash gained or lost by a company. A positive cash flow statement indicates profits and a negative net cash flow indicates that the expenditure was higher than earnings.
Example of A Cash Flow Statement
We have the below dataset that constitutes cash flow statements from the operating, financing, and investing activities of Company A in 2021. Let us calculate the net cash flow of Company A for 2020-2021.
The company has an opening balance of US$ 1450 million.
|Source||Line Item||Amount (US$, Millions)|
|Cash flows from operating activities||Net cash provided by (used in) operating activities||-237|
|Total cash flows from Operating Activities||-237|
|Source||Line Item||Amount (US$, Millions)|
|Cash flows from financing activities||Medium and long-term borrowings – New issues||64651|
|Cash flows from financing activities||Medium and long-term borrowings – Retirements||-29877|
|Cash flows from financing activities||Net short-term borrowings||-7659|
|Cash flows from financing activities||Net derivatives – Borrowings||394|
|Cash flows from financing activities||Net derivatives – Other assets/liabilities||73738|
|Cash flows from financing activities||Capital subscriptions||886|
|Cash flows from financing activities||Other capital transactions, net||383|
|Total cash flows from Financing Activities||102516|
|Source||Line Item||Amount (US$ in Million)|
|Cash flows from investment activities||Loans – Disbursements||-13578|
|Cash flows from investment activities||Loans – Principal repayments||8376|
|Cash flows from investment activities||Loans – Principal prepayments||7262|
|Cash flows from investment activities||Loans – Origination fees received||37|
|Cash flows from investment activities||Loans – Other investment activities, net||-282|
|Total Cash Flow from Investment Activities||1815|
Net Cash Flow = Total Cash Flows from Operating Activities + Total Cash Flows from Financing Activities + Total Cash Flows from Investment Activities
Net Cash Flow for Company X = A + B + C
=> (237) + 102516 + 1815 = US$ 104,094 million
Hence, Cash and Cash Equivalents, End of Year = Initial Balance + Net Cash Flow = US$ 1450 million + US$ 104,094 million = US$ 105,544 million
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