A cash flow statement is important to your business because it can be used to assess the timing, amount and predictability of future cash flows and it can be the basis for budgeting. A cash flow statement can answer the questions, ” where did the money come from?” “Where did it go?"_
This Business Builder will introduce you to the cash flow statement and its importance for financial management. Through the use of a worksheet, the Business Builder will guide you through the construction of a cash flow statement for your business. The cash flow statement is a complex financial statement and by necessity, this Business Builder contains information on sophisticated accounting topics.
For your business, the cash flow statement may be the most important financial statement you prepare. It traces the flow of funds (or working capital) into and out of your business during an accounting period. For a small business, a cash flow statement should probably be prepared as frequently as possible. This means either monthly or quarterly. An annual statement is a must for any business.
A cash flow statement can be used to assess the timing, amount and predictability of future cash flows and it can be used as the basis for budgeting. You can use a cash flow statement to answer the questions, “where did the money come from?” “Where did it go?” A loan officer will use cash-flow analysis techniques to evaluate the firm’s ability to generate cash to repay a loan. A cash flow statement is also a key to understanding the investment and financing philosophy of a borrower. It will be used by your banker to answer the question, “Does this company have enough cash to make payments on a loan?”
The cash flow statement became a requirement for publicly traded companies in 1987. There are various rules governing how information is reported on cash flow statements, as determined by generally accepted accounting principles (GAAP). While your business may not be a public company, a cash flow statement is still important to measure and track the flow of cash into and out of your business.
Watch Out For… Cash flow is not the same as net income. Cash flow will not match the amount of net income shown on your profit and loss (P & L) statement. This is because net income includes noncash items, such as depreciation. And also because net sales are sales not cash payments.
How to Prepare a Cash Flow Statement
In the accounting, banking and business communities there has been much debate as to the best method to report cash flow information. Accounting experts recommend using three categories to organize cash flow data: operating activities, investing activities, and financing activities. However, there are two possible approaches to reporting cash flow from operating activities: the direct method and the indirect method. Since 1987, the Financial Accounting Standards Board – the rule makers of the accounting community – have encouraged the use of the direct method. However, most companies continue to report operating cash flow by the indirect method.
How to Prepare a Cash Flow Statement
This Business Builder will introduce you to both. You will need to make a decision as to which method you will use. However, under the direct method, it is necessary to reconcile net income reported on the P & L statement to net cash flow from operations on the cash flow statement. (This is the same as using the indirect method to compute cash flow from operating activities.) It may seem like a Catch-22 situation – you can choose either method, but if you choose the direct method, you must also compile operating activities according to the indirect method. (But, if you choose the indirect method, you DO NOT have to also compile cash flows according to the direct method.)