What is a Cash Flow Statement?
What is a cash flow statement?
A cash flow statement is a part of the three financial statements that a company is required to prepare. This statement tells us how much cash is there with the business at the end of a particular period, unlike an income statement that basically tells us how much income has been generated. The cash flow statement doesn’t follow accrual basis accounting where income and expenses are only recorded when earned or incurred. The cash flow statement makes changes in the income statement’s information. For example, depreciation in an income statement is treated as an expense. But there is no cash exiting the business when charging for depreciation. So the cash flow statement adds back the expense and reverses the entry. So you see how much cash is actually present, not the income.
Purpose of a cash flow statement
The cash flow statement helps us for four different reasons:
It shows us the actual liquidity in the company. Which means how much cash flow is available for usage.
It shows us the changes between assets, liabilities and equity in terms of cash inflow and outflow and how much is held with the company.
It allows us to predict cash flows that might occur in the future by creating cash flow projections.
If you’re applying for a loan, the cash flow helps in showing your company’s current liquid position.
A positive balance at the end of the cash flow statement means there is cash available. A negative balance means the company is out of cash. But neither are just good or bad, other factors help determine whether a particular kind of cash flow is good for the company or not. Companies hire bookkeepers to make cash flow statements or they can use softwares like excel to generate one. There are two methods of calculating cash flow.
1. Direct method:
In this method, the business is required to keep a track of how much cash is flowing in and out of the business and then the statement is prepared the end of the month. This method requires organization and proper records because each receipt for every cash transaction is important and needed. This is why small businesses avoid direct method and prefer indirect method.
2. Indirect method:
In the indirect method, the reversal and addition of transactions takes place. The business is required to assess the transactions that are recorded on the income statement and reverse some of those to arrive at the working capital. So we backtrack to reach the point where no movement of cash has occurred. It’s much simpler than the direct method. And in this method, no reconciliation of statements has to occur.
The information present in the income statement and balance sheet helps us generate the cash flow statement. The income statement shows us the inflow and outflow of money whereas balance sheet shows us the changes occurring in the asset and liabilities accounts. So the generation of financial statements for your business takes place like this:
Income Statement + Balance Sheet = Cash Flow Statement
