Bookmark this page

DeliciousDiggStumbleuponGoogle BookmarksReddit

 Cash Flow Statement’s can be Understood !

There are two ways to look at a cash flow statement.  We could define what it is or what it does.  The same way we could define a drill by what is looks like or what it produces, which is holes.  I would rather explain to you what the cash flow statement does and why we need it.

There are two basis for accounting, accrual or cash basis. Accrual basis accounting recognizes income when it is earned and expenses when they are incurred.  What that means is that if a product or service is sold without being paid for it is still part of income on the income statement.  In addition if a product or service is used without being paid for it is still considered an expense on the income statement.  So on the accrual basis you could have a business that is showing a profit while experiencing a cash flow crisis such as bouncing checks or not paying loans on time.  If this same income statement was prepared on a cash basis there would be no income unless the service or product was paid for.  They're also would be no expense until the product or service used was paid for.  So if a company would be late in paying their bills on a cash basis they could actually improve their bottom line! .  By now you probably understand that like with anything in the real world there can be problems with both accrual basis accounting as well as cash basis accounting. 

To resolve the problems associated with both the cash and accrual basis for accounting we have the cash flow statement. The cash flow statement allows one to look at accrual basis financial statements and understand how they would look if they had been prepared on a cash basis. The cash flow statement converts the income statement to sources and uses of cash.  A simpler way of stating sources and uses of cash might be just incoming and outgoing money.

The cash flow statement is separated into three categories.  The first category is operating activities which means the cash flows generated by selling goods and services.  The second category is investing activities, that means the purchase of long-term assets that a company needs in order to make and sell its products as well as the selling of any long-term asses then no longer needed by the company.  The third category is financing activities, that means the cash flows that come from or go to investors or banks that give the company cash.

Each category in the cash flow statement is added together separately to come to a total of cash flow from provided by or used by each activity. The sum total of all cash flows provided by or used by the activities will equal to the change in cash for the period.

I hope you now have a better understanding of what a cash flow statement is.  It can be used to analyze a business and see if it is using its cash effectively or is on the edge of a potential crisis.  Please be aware that even if a business is building up significant balances of cash and increasing its cash that does not necessarily mean that the businesses being run wisely.  Cash is like any other asset in the business than it should be producing income otherwise it is a waste.  The analogy that I usually tell my clients is you wouldn't want your employees to be taking the day off and getting a tan on the beach, likewise you don't want your dollar bills lazying around at the bank without getting a significant return.