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The Cash Flow Statement (CFS) tells you exactly how money flows in and out of your company. It is a report that helps visualize the income and expenditure of the company. Investors and business managers alike can use the report to determine if the company is managing its finances optimally or if there is room for improvement. A healthy cash flow is a positive indication of good financial management and a robust company. A cash flow statement may not indicate unwise spending but may also reveal that the company has become very sluggish in its operations.
The cash flow statement is a report that gives details about the company’s cash flow over a period of time. Though the term ‘cash’ is used, it also applies to cash equivalents. It details the amounts of money that the company is earning and spending, showing how the cash flow has changed in that time.
The cash flow statement is an essential document for investors and stakeholders in a company and is prepared annually from the operating, investing, and financing activities but can even be made for shorter time intervals. Cash flow analysis is the study of the cash flow through the business. The utilization of cash flow data to project future cash flows is called cash flow forecasting.
The activities that reflect on the cash flow statement include:
Operational activities: These activities are integral to the company's purpose and include revenue income, payments to vendors, cost of utilities, and other such transactions.
Financial activities: Activities that involve the capital of the company, borrowed money, and transaction of securities are financial activities. They are separate from operational activities.
Investment activities: The losses and gains of the company through activities such as buying/selling of assets and loan payments are investment activities.
So, the cash flow statement lets the business owner and management of a company track the cash flow in the company from all streams in a single report.
The cash flow from operations is voluminous. It extracts information from the daily transactions relating to core operations. The CFO reports the transactions from the accounts receivable, accounts payable, etc. It helps the reader determine how much money the company is transacting. It is also informative for the company’s stakeholders to determine how the operations are being run.
Companies use their money to invest in property, equipment, vehicles, stocks, and bonds. These investments or capital expenditures are a part of the cash flow from investing.
The transactions of a company for financing-related activities such as loan payments, issue of stock, dividend payments, and transacting bonds comprise the CFF section of the cash flow report.
Net Cash Flow: The sum of the different cash flow activities makes up the net cash flow. We can calculate the net cash flow as:
Net Cash Flow = Cash Flow From CFO + CFI + CFF
The cash flow report helps visualize the cash flow of a company, and it also helps the reader evaluate the historical and current cash flow patterns of the company. This can be used to generate cash flow projections, study how the company has evolved, and estimate how it is expected to perform based on its record.
An investor would want to put money into a business that is likely to perform well and grow. In addition to the balance sheet and income statement, a careful perusal of the cash flow statement is important to understand how the company is managing its money. The importance of cash flow statement lies in the fact that it gives a more detailed picture of the company’s finances than the other statements. It also shows the balance between the operational, investment, and financial activities of the company. It tells the investor how solvent the business is, which is an essential aspect of the company's financial stability. While the overall reports of the company give the investor the bigger picture, the cash flow statement reveals just how much of the cash flow generated is a part of the company’s core business activities. The comparison of the cash flow statements of similar companies reveals a lot about their difference in managing their finances. If the company is carrying a debt burden, the cash flow statement helps the investor assess the company’s capability of repaying the debt. By making projections from the cash flow statement, the timing and volume of the future cash flows can also be estimated. This is another importance of cash flow statement.
Cash flow analysis calculates different ratios that give a numerical evaluation of the company's cash flow. The essential cash flow ratios are:
Operating Cash Flow Ratio: This is the cash flow ratio that reveals the company's liquidity. It helps the financial analyst or investor calculate if the company’s operational cash flows are sufficient to cover its liabilities.
The formula for the operating cash flow ratio is:
Operating Cash Flow Ratio = Cash Flows From Operations / Current Liabilities
The cash flow from operations can be extracted from the cash statement, and the current liabilities are listed on the balance sheet. If this formula calculates a value less than one, it means that the company is generating insufficient money to repay its debt which is a red flag for the investor.
Cash Flow Margin Ratio: This ratio tells us about the company’s ability to translate sales activities into cash. It is the percentage of the cash from operating activities versus the sales activities of the company. The cash flow margin should be as high as possible. The formula for calculating the cash flow ratio is:
Cash Flow From Operating Cash Flows / Net Sales = _____%
Current Ratio: The ratio between the current assets and the current liabilities of the company is the current ratio and it indicates if the company has enough current assets to cover its liabilities. It is also a measure of the company's liquidity and indicates how well it can meet its short-term debts.
Current Ratio = Current Assets / Current Liabilities
Quick Ratio: This is the most specific test of the company’s liquidity. Most ratios that measure liquidity also include inventory as a part of the calculations. The quick ratio is called the acid test because it does not include inventory. It determines if the company has enough liquidity without the option of selling inventory to meet its short-term liabilities.
The formula for quick ratio is:
Quick Ratio = Current Assets - Inventory / Current Liabilities
If the calculation results in a number that is less than one it means that the company would have to liquidate inventory to meet short-term obligations and this is not an indication of good financial health.
Regular cash flow analysis tells you how well your company is managing its cash flows. This report is traditionally calculated annually. But with software like TallyPrime that holds all the accounting data in one place, you can generate a cash flow report for smaller periods. The specific insights that this report gives you will help steer your company into better cash management practices. Good cash flow and management results in excellent financial health. The importance of cash flow statement is that it zooms in on the bigger picture that the balance sheet and income expense statement give you and lets you analyze the cash flow independently.
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