Cash Flow is indicative of a company’s financial health. Problems in cash flow may point to issues in product pricing, operating efficiency and credit policy. Statements of cash flow give an indication of what needs to be rectified and realigned.
Below is the Statement of Cash Flow of Innovative Products Inc.
Sample Cash Flow Statement
Cash Flow by Activity
A business receives and distributes cash through the transactions that are carried out in its normal operations. These transactions can be categorized into three activities:
Operating activities: Operating activities are transactions that affect the net income, or the revenues and expenses. Cash flows in from selling goods or services. Cash flows out from expenses incurred to operate the business, such as rent, wages, insurance, payments to suppliers, and buying office supplies.
Investing activities: Investing activities are transactions that affect the assets. Cash flows in from selling land, buildings, plants, equipment, or intangible assets. Cash flows out from purchasing land, buildings, plants, equipment, or intangible assets.
Financing activities: Financing activities are transactions that affect the owner's equity and long-term creditors. Cash flows in from borrowing cash on a short-term basis, investments made by the owner, or issuance of notes payable. Cash flows out because of the owner's withdrawals or repayment of cash loans.
How Funds Come In?
There are several categories of cash that can flow into a business:
Net income – This is the money the company makes from selling products and services to customers. Taxes and some basic operating expenses are deducted from this amount. This amount can be found on the company's income statement.
Depreciation expense – This is calculated when a company buys a fixed asset. The cost is deducted as an expense over time. However, this expense is a source of funds in the sense that the company makes back the money it spends over time as these costs are passed on to customers.
Bank notes – These represent short-term funding the company uses to raise money. Although this money has to be paid back, it is considered a source of funds in the short term.
Increase in accounts payable – Increase in accounts payable means the company is taking more time to pay bills, buying products on credit, or paying higher prices for credit purchases. This money is available as cash until it is used to pay these bills.
Decrease in investments – A decrease in investments appears any time an investment is sold. After the sale, more money is available to the business. Even if the investment is not profitable based on the original price, there is still some amount of money coming into the company.
By exploring a company's cash flow statement, you can gain a picture of the financial health of the company. For example, if the major source of funds is net income, then the company isn't relying on debt to fund its activities. You can also gain a picture of the debts and financial obligations that are current sources of funds, but will be costs for the company down the road.
Determining How Funds Are Used
You can control your personal budget by analyzing how you spend your money. The same is true for a company. You can learn a lot about how the company functions by examining the uses of funds.
There are several ways that a company can use money. A cash flow statement explains the different ways money is used at the company:
Capital expenditures – When a company has capital expenditures, it has spent money to either buy or improve fixed assets. This money is considered an investment and can vary considerably among time periods.
Increase in inventory – Inventory is the amount of product the company holds. It can increase because costs have changed, sales are down, or because more expensive products are being held in the company's inventory.
Decrease in long-term debt – Long-term debt can be decreased for a number of reasons. Interest rates may be high, so the company decides to pay off the loan. The company might have more money than usual, or it might use short-term debt to pay off the long-term debt.
Payment of cash dividends – This occurs when the company has made money. Companies often make payments to stockholders when a profit is produced.
Cash reconciliation – This is the company's cash balance, plus sources of funds, minus uses of funds, equals increase in cash, which accounts for the company's total cash balance.
You can use your company's cash flow statement to learn a lot about the business. Specifically, you can learn what kind of money comes into your business, and how this money is spent. Cash flow statements are one of the valuable tools you can use to evaluate the health of your company.
