How do you know if you’re running a successful business or not unless you know about your cash flow?
While there are many ways to define success for a business, certainly one of the best and most common ways is how much cash is flowing around your company.
That’s why along with income statement and balance statement, the cash flow statement (CFS) is one of the three most important financial statements.
Each of these financial statements is essential for the accounting of any small business.
Even though it is often downplayed by many small businesses, investors see the cash flow statement as perhaps the most important of all. Many people have heard of the cash flow statement, but what exactly is it?
To find the answer to this question and more, keep reading for our guide on what you need to know about cash statements.
What’s Cash Flow?
Before we get into cash flow statements, it’s important to know the answer to the question – what exactly is cash flow?
It’s as simple as the name suggests. It’s the cash going in and out of your business. This mostly referred to as “cash in” and “cash out”.
It’s often compared to a water tank. Water is always flowing in into the tank while also draining out.
That’s why a healthy cash flow ensures that your business is running well. After all, if you have plenty of money flowing around the business, this suggests your company is good with money.
What’s the Cash Flow Statement?
The cash flow statement is otherwise called the statement of cash flows. It is simply the summary or report of the cash flow in your company.
If you have a good cash flow, you have a healthy business. In addition, this suggests that your business has the potential to expand and pay off any debt you might have.
Along with the other financial statements of balance and income statements, it’s a requirement of every registered business. But you need the two others before you can complete your statement of cash flow.
That’s why it’s essential that every small business understands what a cash flow statement is and how it works.
Why Cash Flow?
But this raises the question – why cash flow?
There are many different methods of analyzing a business. From the way a company treats its customers to the value of the company’s assets. However, these all have drawbacks compared with cash. This is why Forbes declares, “cash is king“.
And yet, it’s widely considered to be the best way to measure how a business is performing.
One of the biggest advantages of cash flow is that it’s easy to measure. This is simply because money is a tangible and quantifiable thing. The standard unit in business is US dollars. This is widely recognized and accepted.
For the same reason, it’s easy to measure cash, this also makes it easy to compare. It might seem difficult to compare a company that sells travel insurance with a grocery store. But with cash flow statements, it’s possible.
But why do we want to compare? This is because investors and creditors are eager to compare the difference between companies so they know where to invest and who to lend to.
There are many illegal and unscrupulous ways of fixing a company’s profits or assets to make it look as though the company is more successful than it is in reality.
However, you can’t do this so easy when it comes to cold, hard cash. That’s the beauty of cash flow statements. They’re a legitimate and trustworthy indicator of the success of a company.
4. Universally Accepted
There are many ways of indicating the success of a company that people won’t universally agree on.
For instance, say 9/10 customers are satisfied with a service. This may appear to be positive, but some companies or investors might not consider this important.
However, nobody questions whether $10 is worth the value of $10. Everyone accepts the value of cash. That’s why cash flow statements are often the best way of judging the success of a company.
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Why do Cash Flow Statements Matter?
There are several uses of cash flow statements.
Investors, creditors and the company itself make up three of the main groups with various uses for cash flow statements. Let’s take a look at why cash flow statements matter for these three groups.
1. The Investors
Investors use cash flow statements to get an understanding of how the business is being run. The statement of cash flow gives investors the bigger picture.
Investors want to know the different indicators that signify business success or failure. This includes the sources of the money for the business operations. As well as, how the company spends the money it generates.
However, it’s maybe primary use for investors is to get an insight into the financial situation of the business. In other words, it informs investors about whether they should consider putting money into a business or not.
2. The Creditors
On the other hand, creditors have another use for cash flow statements. They want to use the cash flow statements to learn how much liquidity (money) the business has to pay for its operating costs.
Even more importantly, creditors want make sure you pay off any debts the business might have incurred. This allows them to judge whether they can continue to lend the company money, or whether they should turn off the taps.
3. The Company
The company benefits enormously itself from producing statements of cash flow.
This is partly because if the cash flow shows a healthy business, this could result in increased investments and the ability to acquire loans from banks to further drive your business.
This provides you with a long-term view of how your business is doing. The more cash that’s available for your business, the better you’re doing.
However, it’s also important to realize that if the cash flow statement results in poor findings that reflect badly on the business, this could have negative effects on the future growth of the company.
And yet, it’s still required that companies conduct cash flow analysis and produce statements.
The Categories of Cash Flow Statements
The cash flow statements display the overall cash flowing in and out of the company. However, the statement is also structured in a way that divides the cash flows into three categories. These include the following:
- Operating activities
- Investing activities
- Financing activities
In contrast to other types of financial statements, the cash flow statement does not include either future income or outgoing cash flows. Because of this, “cash flow” is different from net income of the company.
1. Operating Activities
Operating activities refer to any cash flow that relates to general business activities. Therefore, this is the part that includes the income generated from the products and services the company produces.
Examples of operating activities include everything from sales of goods and services, income tax, rent costs and salary payments to employees.
2. Investing Activities
The investing activities are uses or sources of money from the investments made by a company. For example, if the company bought or sold assets. If a merger or acquisition occurred, this would also fall into the investing activities category.
It’s worth noting that the vast majority of investing activities are outgoing cash flows. This is because most companies have to invest cash into equipment or buildings. Whereas, it’s much less common for a small business to regularly sell assets.
3. Financing Activities
The financing activities refer to cash generated from investment in the company or credit acquired from banks and other sources. This also includes anything paid out to shareholders.
When capital is raised through investments or banks, this is cash in, whereas, dividends and other payments are cash flowing out of the company.
Get Started with Your Statement of Cash Flow
A cash flow statement is an essential element of every business. It not only shows investors and creditors that your business is built on solid financial foundations. But it’s also important for you to know whether you’re achieving your business goals.
With this knowledge and information about cash flow statements in mind, it’s time to get started with your own statement of cash flow. However, for many small businesses, this is a drain on resources that you can’t afford.
That’s why many small businesses outsource company accounting to the experts. This way you know for certain that your statement of cash flows and other accounting tasks are being run effectively. To find out more about outsourcing your accounting, get in touch with us today!