Cash management in a business can sometimes be complicated. What with payment terms, trade payables and outstanding customer payments, it is easy to lose track of what money is coming in to your business and going out. To help you get a clearer view of your inflows and outflows, there is a very handy (not to say essential) tool to put in place: a cash flow statement.
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Not only are they used in the strategic management of a company or for a funding round for example, cash flow statements can also greatly facilitate financial monitoring. What are the advantages? How do you build a cash flow statement? And how do you interpret the data and results?**
Agicap provides all the answers in this article.
An essential financial document for managing a business, a cash flow statement shows your company’s inflows and outflows over a given period, called an accounting period. This table compiles all past cash flows and allows future cash flow forecasts to be made. It generally has three sections: operating activities, investing activities and financing activities. The total cash brought in or used up by each of the three activities is then added together to give the total change in cash flow for the period.
A cash flow statement shows the ability of a business to operate in the short and long term thanks to sufficient liquidities. Ideally, the cash flow from your operating income should be greater than your net profit. Positive cash flow demonstrates your company's ability to remain solvent and grow its business.
Together with the balance sheet and income statement, the cash flow statement is one of the three most important financial statements for managing a company's accounts.
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Whether you are a company manager, an entrepreneur or an investor, knowing how to read and understanding a cash flow statement are vital to get a clear picture of a company’s financial health. As it represents a map of cash flows, the cash flow statement helps to make key decisions (commercial, strategic, investment, etc.) in an informed manner. With a cash flow statement, you can:
assess the change in cash flow generated by your company’s operations;
understand the financial health of a business at a glance;
analyse the company’s capacity to finance its cash-demanding investments and meet its financial commitments;
identify the company’s strategy (internal or external growth, etc.) and its impact on its future;
understand how the company generates cash and how it uses it year over year.
The cash flow statement is a useful tool for regular financial monitoring for many reasons: 1. A good indicator of your liquid assets With a cash flow statement, you are fully aware of the cash flows at your disposal. So you know what you can and cannot afford in your strategic choices.
2. Changes in assets, liabilities and equity You can quantify the amounts of cash outflows and inflows and the liquid assets your company actually holds. These three categories form the accounting equation to measure your business performance.
3. Plan future cash flows You can use cash flow statements to create cash flow projections. For example, this can allow you to prepare your next medium- and long-term business plans.
As its name suggests, a cash flow statement compiles all the cash flows in a financial document to enable cash flow management in a business. In other words, it measures the cash inflows and outflows (net amounts) of the company. This is known as “Cash in” and “Cash out”.
There are several categories of cash flow: cash flow from operating activities, cash flow from investing activities, cash flow from financing activities, self-financing capacity, free cash flow and change in working capital. Let's explore each family of cash flows in detail.
Cash Flow from Operating Activities Cash Flow from Operating Activities details the cash flows generated once the company has delivered its usual goods or services and includes both income and expenditures. It corresponds to turnover without including investing and financing activities. This surplus therefore expresses the monetary value of the wealth the company creates. In particular, it allows loan repayment, dividend distributions, and self-financing of certain investments, etc.
In most cases, cash flows from operating activities account for the majority of your cash flow. If you run a restaurant, for example, Cash Flow from Operating Activities is the result of your sales minus your expenses (raw materials, equipment, rent, payroll, etc.).
Cash flow from Investing Activities Cash flow from investing activities incorporates cash flows from the purchase or sale of assets (tangible property such as real estate or vehicles, and intangible assets such as patents) using available funds rather than debt.
You can use the formula below to evaluate cash flow from investing activities: Cash flow from Investing Activities = acquisitions of intangible and tangible fixed assets – acquisitions of entities (equity interests) + disposals of intangible and tangible fixed assets + disposals of entities (equity interests)
For very small businesses and SMEs, Cash Flow from Investing Activities generally only accounts for a small part of the business’s cash flow. But you should still keep an eye on it as it can have an impact on your working capital.
Note that: when you spend cash on an investment, that cash is converted into an asset of equal value. It has a monetary value, but it does not correspond to available funds (and in this context, the only assets we are interested in are available funds).
Cash Flow from Financing Activities Cash flow from financing activities concerns income and expenses from borrowings and equity. In other words, cash flow from financing activities corresponds to calculating the revenue generated and amounts spent in the context of financing activities. For example, this may be the repayment of part of a bank loan, the entry of a new investor in the business or the use of a line of credit. The calculation below gives the value of cash flow from financing activities: Cash Flow from Financing Activities = Capital increase + Medium-and long-term borrowings – Repayment of medium- and long-term borrowings +/- variation in shareholder loans – dividends paid.
Self-Financing Capacity This indicator, which is sometimes underestimated by managers, relates exclusively to the business carried out by a company. Self-financing capacity determines whether the business has generated more money than it spent, and therefore shows whether its business model is profitable. In practical terms, self-financing capacity is equal to all the gross resources available at the end of an accounting year. The company can ultimately use it to: evaluate its financial health (together with other financial indicators such as cash flow) - finance certain investments - repay part of its loans - calculate the amount of dividends to be paid to shareholders
Free Cash Flow You may also need to assess the free cash flow, i.e. the liquid assets remaining after subtracting asset disposals, any investments, WCR and taxes on operations. The free cash flow formula is: Free cash flow = cash flow from operating activities + cash flow from investing activities. The free cash flow formula can also be detailed as follows: Free cash flow = GOS + disposals of assets – investment + change in WC – tax on profits.
Change in WC The surplus of assets over liabilities is called the company’s working capital (WC). The “change in working capital” is therefore the difference between the working capital of two separate accounting periods (year, quarter or month). To calculate the WC, current liabilities are simply subtracted from current assets.
Change in working capital is included in cash flow from operating activities since a company generally increases or reduces its current assets and liabilities to finance its ongoing operations. There are two possible scenarios:
Increase in current assets: this is an outflow of funds. The company has to pay out money to buy extra assets.
Increase in current liabilities: this is an inflow of funds. Extra debts, such as short-term debts, provide the company with cash.
Interpreting changes in working capital for a company Based on the history and target strategy of the business, these changes can generally be explained as follows:
when the change in working capital is negative, it may mean that the company is investing heavily in its current assets or significantly reducing its current liabilities;
conversely, if the change in working capital is positive, the company is selling current assets or increasing its current liabilities.
For many businesses in the growth phase, changes in working capital mainly correspond to capital expenditures: this is the cash that the business decides to invest in order to develop. A company must therefore calculate this change to be sure that its WC is sufficient and it will not end up short of funds.
There are two methods for drawing up a company's cash flow statement: the direct method and the indirect method.
This first method is based on transactional information that had an impact on cash flow during the period analysed. This method consists in integrating all the inflows from operating activities and subtracting all the outflows from operating activities.
The second method, referred to as indirect, is based on accrual accounting. In principle, a company's accountant does not record income and expenses at the exact time of cash transfers. As a result, these accruals and adjustments (and therefore the cash flows from operating activities) differ from the net income.
By using the indirect method, the accountant starts from the net income in the income statement and makes adjustments to cancel out the impact of accruals and deferrals over the period. The net income must then be converted into a real cash flow by identifying all the non-cash expenses over the period under analysis (such as depreciation, asset write-downs, amortisation or payments spread over several accounting periods).
By the time you reach this section, you should have grasped the basics of cash flow. Note that there are two main types of statements: the cash flow statement based on operating income (OI) which is preferred by banks and the cash flow statement based on gross operating surplus (GOS), preferred by investors and funds.
Operating income (OI) measures the company's ability to generate resources through its core business, i.e. the company's gains or losses before deduction of interest and taxes. Since it is not influenced by the financial structure of the company, OI is a good indicator of its economic performance.
Operating Income does not include financial income and expenses, or tax on profits, but unlike GOS, it includes the investment process with amortisation and provisions. We refer to:
Average OI, i.e. the average of the sum of all operating income over the last three accounting periods;
Restated OI, i.e. the average OI adjusted for debt, net cash, and shareholder claims or debts;
Weighted operating income, corresponding to the sector coefficient on OI-specific multiples.
A cash flow statement can also be built based on gross operating surplus (GOS). Below is a model that can be customised:
Building a cash flow statement is not an easy task and certain documents and financial information are needed.
Here are the main documents you need:
income statement (to calculate the self-financing capacity);
balance sheet and notes (table of fixed assets, etc.);
statement of changes in financial position (change in working capital, financing transaction, dividend distribution, etc.).
Important: It is essential to take both actual cash flows and future cash flows into account when building a cash flow statement. To assist business managers in this process, two types of cash flow statements are generally used in France:
the statement of the French association of public accountants (OEC);
the statement designed by the Banque de France Balance Sheet Office (CDB).
The forecast section of your cash flow statement must be updated with the actual cash flows. Make sure you adjust your cash flow forecasts so that you do not find yourself in difficulty due to forecasts out of sync with reality.
Err on the side of caution when making your assumptions. Making rash predictions and setting unattainable sales targets can be detrimental and distort your forecasts, which are unlikely to reflect the reality.
Filling in your cash flow statement demands discipline and patience in order to have the information you need to manage your business. So, set some time aside to do this and enter all your company’s cash movements in the statement.
A company whose volume of business varies with the time of year (high and low seasons) does not have consistent cash flows all year round: a significant drop in sales over a given period does not necessarily mean that your expenses are any lower.
Granting your customers payment facilities can be an excellent way to build trust and reward their loyalty; but, be careful not to overlook the impact on your cash flow! For example, if your sales volume is high in June but you only receive payments 45 days later, you cannot count on those inflows to pay your expenses for June.
Doing a regular cash flow audit provides an early indication of the financial health of a company. Cash flow is generally referred to as positive (the company receives more cash than it spends) or negative (the company spends more cash than it receives).
Positive cash flow A positive cash flow means that a company has more money coming in than going out over a given period. In theory, this is the ideal situation. Thanks to the surplus cash it generates (through operating activities in particular), the company can invest in its development, decide to reward its shareholders or pay off its debts. But bear in mind that a positive cash flow does not necessarily lead to profits. Your business can be profitable without having a positive cash flow, and you can have a positive cash flow without making a profit.
Negative cash flow Does your ‘cash out’ exceed your ‘cash in’ over a specific period? If it does, then your cash flow is negative. But there is no need to panic: negative cash flows do not necessarily mean you will make a loss in the medium or long term. On the contrary, the situation may be due to important decisions you made some time ago to expand your business or invest in your growth. However, if you notice that your expenditures and income don’t match over several consecutive accounting periods, you should take action to reverse the trend as soon as possible.
Based on this information, an investor may decide, for example, that a company with irregular cash flows is too risky to invest in, or that a company with positive cash flows is ready to grow. Within a company, a manager can look at a cash flow statement to understand how their department affects its finances. They will then be able to make adjustments and adapt the operations of the entire department (budget, hiring, lay-off, etc.).
Past cash flow statement This statement can be drawn up by a company member and should include all financial flows over the period analysed. Building this statement demands great precision to ensure nothing is left out.
Cash flow forecast It's a good idea to draw up a cash flow forecast if you want to (re)review your strategy or if you are thinking of (re)defining your business plan. The cash flow forecast is generally prepared yearly over a period of time consistent with the development plan and the duration of returns on structural investments.
By applying the tips you have found in this article, you can now build and regularly update a cash flow statement for your business.