Cash flow statement: what you need to know

Managing a company's cash flow can sometimes be complicated. Late payments, outstanding supplier bills, overdue customer payments... It's easy to lose track of past and future cash flows. To help you see your sources of cash more clearly, there's a practical (if not essential) tool you can use - a cash flow statement.

Whether used in the strategic management or when raising funds, the cash flow statement can make financial monitoring much easier. What are the advantages of using the cash flow statement when making decisions? How do you build one? How should the data and results be interpreted? Agicap provides all the answers in this article.

What is a cash flow statement, and why is it important? Definition

The cash flow statement is a key financial document in the management of a company. It shows the cash inflows and outflows over a given accounting period. The statement is generally divided into three sections: operating activities, investments and financial activities. All cash flows provided or used by each of the three activities are then added together to determine the net increase or decrease in cash during the accounting period. By analysing the cash flow statement, managers can gain valuable insight into cash generation and expenditure, and forecast future cash flows.

What’s more, the cash flow statement demonstrates a company's ability to operate in the short and long term with adequate liquidity. Ideally, cash flow from operating income should be greater than net income. Thus, a positive cash flow demonstrates a company's ability to remain solvent and expand.

Thus, along 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.

Why have a cash flow statement?

Whether you are a company director, entrepreneur or investor, being able to read and understand a cash flow statement is essential to assessing the financial health of your business. The cash flow statement allows you to make key decisions (commercial, strategic, investment, etc.) in an informed manner. It allows you to:

• assess the cash flows generated by the company's activities
• get an overview of the company's financial position
• analyse the company's ability to finance cash-generating investments and to bear the costs of its obligations;
• determine the company's strategy and its impact on the future;
• understand how the company generates cash and how it uses it.

The cash flow statement is a useful tool for regular financial monitoring for a number of reasons:

1. A good indicator of your liquidity

Thanks to the cash flow statement, you are perfectly aware of the state of your cash flow. You can therefore see what you can and cannot afford in terms of your strategic choices.

2. Changes in cash

You can quantify the increase or decrease in outflows, inflows, and actual cash availability in the company. These three categories form the accounting equation for measuring your business performance.

3. Forecasts of future cash flows

You can use cash flow statements to create cash flow projections. This can help you, for example, to draw up your future medium- and long-term business plans.

Cash flow statement components explained

As its name suggests, the cash flow statement brings together all cash flows and is used to manage a company's cash more effectively and consciously. It takes into account all the cash inflow and outflows.

What are the 3 cash flows in a cash flow statement?

In preparing the statement of cash flows, we present operating, investing and financing cash flows. Let's have a closer look at each of them.

⭐ Cash Flow from operating activities

Operating cash flow represents the cash flows generated from regular business activities. It includes the cash effects of various transactions and events related to a company's day-to-day operations.

In most cases, cash flow from operations comprises the bulk of your cash flow. If you run a restaurant, for example, the cash flow from operations is the result of your sales minus expenses (related to raw materials, equipment, rent, payroll, etc.).

See also: How does Cash flow from operations differ from other metrics?

⭐ 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 accounts for only a small part of the business’s cash flow. Nevertheless, it is worth keeping an eye on it, as it can have an impact on your working capital.

⭐ Cash flow from financing activities

Cash flows from financing activities relate to income and expenses from borrowings and equity. In other words, it corresponds to the income generated and assets spent on financing activities. This may involve the repayment of part of a bank loan, the inclusion of a new investor in the capital, or the use of a credit line.

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.

Cash flow statement : Direct and indirect methods

There are two methods for drawing up a company's cash flow statement: the direct method and the indirect method.

Direct 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 and all the outgoing cash flows.

Indirect method

The second method, commonly known as the indirect method, is based on accrual accounting. Basically, a company's accountant records income and expenses with a time lag in relation to cash transfers. This means that these accrual entries and adjustments (i.e. cash flows from operating activities) differ from net income.

Using the indirect method, the accountant starts from the net income obtained from the income statement and makes adjustments to cancel out the impact of accruals and deferrals made during the period. It is then necessary to convert the net income into a real cash flow by identifying all the non-cash expenses of the period analysed (such as depreciation, the reduction in the value of an asset, amortisation or the spreading of payments over several accounting periods).

How a cash flow statement is prepared?

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 to accounts;
• statement of changes in financial position (change in working capital, financing transaction, dividend distribution, etc.).

5 Practical tips for building your cash flow statement

1. Update your cash flow statement regularly

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.

Read also: 5 Advantages of a Cash Flow Forecast for your Company

2. Adopt a cautious approach

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.

3. Be thorough

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.

4. Take seasonality into account 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.

5. Think about payment terms

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.

Analysing the company's cash flows

Performing a regular cash flow audit is a great way to assess a company's financial health and start making informed decisions. Cash flow is generally referred to as positive (the company receives more cash than it spends) or negative (the company spends more than it receives). There are other financial indicators, such as self-financing capacity, free cash flow and working capital, that will help you to get a clear picture of your financial position.

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 an ideal situation. Thanks to the surplus cash it generates (from its activities in particular), the company can reinvest this surplus to expand, 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

Are your cash outflows greater than your cash inflows during a specific period? This means your cash flow is negative. Don't panic: negative cash flow doesn't necessarily mean you're making a loss in the medium or long term. On the contrary, it may be caused by important decisions taken some time ago to expand your business or invest in your growth. However, if you observe a mismatch between your expenses and revenues for several accounting periods in a row, you need to 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 for expansion. Within the company, managers can examine a cash flow statement to understand the impact of their departments on the company's finances. They will then be able to make adjustments and adapt the operations of the department (budget, hiring, lay-off, etc.).

What are some of the indicators connected to cash flow statement?

⭐ 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 use it to:

• asses 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 free cash flow, i.e. the cash remaining once asset disposals, any investments, WCR and operating taxes have been subtracted.

The free cash flow formula is:

Free cash flow = operating cash flow - capital expenditures

⭐ 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

Depending on the company's history and strategy, it is generally possible to explain these variations 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.

Cash flow statement vs. Cash flow forecast

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.

Empower decision-making with effective cash flow management

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