Mark’s technology company was hiring like crazy. Their growth was through the roof. Then the penny dropped. It seemed like it came out of nowhere. A few key clients were late paying their invoices. Suddenly, money was leaving the company faster than it was coming in. Monitoring his cash flow statement had been the furthest thing from his mind… until he experienced his first cash flow crisis.
Sarah’s trucking company was already struggling with rising fuel costs. Then one of her drivers was in a traffic accident and found to be at fault. The deductibles from the insurance were crippling and unexpected. Her family-owned business that she’d taken over from her father was in danger. If she had been watching her cash flow statements more carefully, she could have seen that her cash reserves were dwindling.
Cash flow is one of the main reasons businesses fail. In Wasp Barcode’s 2017 State of Small Business Report, cash flow was one of the top five concerns, cited by 34% of the businesses that were surveyed.
None of these businesses planned to make a mistake by overlooking the importance of a cash flow statement. They were all doing what they thought was best — taking care of business. At ForwardAI, we make it easier for businesses to take care of business by offering free analytics and insights that include a cash flow forecast.
Table of Contents
- 1 What is a cash flow statement?
- 2 What’s included in a cash flow statement?
- 3 Cash flow from operating activities (CFO)
- 4 Cash flow from investing activities (CFI)
- 5 Cash flow from financing activities (CFF)
- 6 How often should you run a cash flow statement?
- 7 What can a cash flow statement tell you about your business?
- 8 Is there an easy way to run and read a cash flow statement?
What is a cash flow statement?
A cash flow statement (statement of cash flows) is an analysis that shows how much cash is moving in and out of a business during a given period of time.
One of the “big three” financial statements for any business, a cash flow statement both pulls from and supplements the information in your balance sheet and profit and loss statement (income statement).
A cash flow statement shows how changes in the balance sheet and profit and loss statement affect the inflows and outflows of funds for a business.
What’s included in a cash flow statement?
A cash flow statement is generated from an analysis of the revenues and expenses in three main areas:
- Operating activities — How much cash you made or spent to produce the goods and services you sold.
- Investing activities — How much cash you used or made through buying or selling capital investments, like land or equipment.
- Financing activities — How much cash flowed in and out in relation to business loans or other funding transactions.
The amount of cash a business earns or spends in each of these activities is then summarized into an opening and closing cash balance. The summary of the cash movements from all three activities is the net cash movement or total change in the company’s cash position.
If the closing balance is greater than the opening balance, then you have a positive cash flow. On the other hand, if the closing balance is lower than the opening balance, your cash flow is negative.
If, at this moment, you’re feeling like you’re holding an Allen key and trying to assemble European flat-packed furniture, take a deep breath. The above is a top-level overview. In order to show how each of the activities is broken down and combined to create a cash flow statement, we’ll go through each one below.
Cash flow from operating activities (CFO)
Operating activities are all the functions related to producing or providing a company’s product or service. This includes inventory, accounts receivable, payroll and related taxes, like sales tax.
One of the benefits of examining CFO activities and comparing them to net income is that it shows how well a business managing its operations. If everything is going to plan, your CFO will be positive. A negative CFO could come from any number of inefficiencies ranging from pricing issues to outstanding invoices.
Another reason why CFO (operating cash flow) is so important is that it’s also the main way that small to midsized businesses finance themselves. In other words, this is where your “spending money” comes from.
Recording CFO in a cash flow statement can be done either by the direct or indirect method.
- The direct method uses the cash-based system of accounting that only tracks payments that were actually made or received by the business.
- The indirect method uses the accrual system of accounting where payments are recording before they’re actually received by the company.
If you’re not familiar with accounting methods, here’s what you need to know: Cash-based and accrual are the two most common accounting systems. This also means that both the direct and indirect methods of calculating operational cash flow are valid. Ultimately, the choice comes down to what’s best for your business.
Some businesses choose the direct method because it leaves out non-cash transactions. While other businesses choose the indirect method because they are able to pull numbers directly from their balance sheets and profit and loss statements.
When you run a free financial assessment from ForwardAI, we use the indirect method to report CFO. You CFO information will also be broken down visually with charts and graphs to help you see the patterns in your numbers.
Cash flow from investing activities (CFI)
The second area, cash flow from investing activities covers purchases or sales of items that are considered long-term investments. Investing activities can include business equipment, buildings or real estate and even securities. Again, a lot depends on your business, your industry, stage of business and other factors.
One of the reasons the inflows and outflows from investing activities are separated out is that many of these purchases are considered capital items. At tax time, large purchases are depreciated over time, meaning you can only claim a certain percentage of the costs over a specific number of years.
Funds invested in purchases are considered outflow and funds made from the sale of investments are inflow.
When reviewing CFI, remember it’s a long-term play and the results are taken into consideration along with other activities. For example, if you’re business is in growth mode, you may be investing in equipment and other capital to help fuel further growth.
Cash flow from financing activities (CFF)
Depending on the size and structure of a business, cash from financing can include the size and payment amounts of business loans or the payment of dividends for incorporated businesses. For startups, this would include fundraising as well as any amounts paid to investors.
Using a small business loan as an example, the money your business receives from the loan is counted as an inflow, while the loan payments are outflows.
A business’ CFF is used as a variable for measuring equity (ownership) as well as lending risk. For example, if you have a lot of debt, but it’s not being used to fuel growth or produce results, you would want to start thinking of ways to pay down the debt. Similarly, an outside business or analyst might also highlight or a high level of debt as a consideration or concern.
How often should you run a cash flow statement?
The general consensus is monthly. However, if your cash flow changes quickly or you’re a new business, you may want to consider looking at your cash flow every week.
Once you make creating a cash flow statement a routine part of your financial analysis, you’ll start to build a history of your cash flow. In turn, this will help you identify trends, such as when your cash flow peaks or hits valleys.
The more you learn, the more you’d wish you’d started tracking your cash flow even earlier. It’s sort of like eating your vegetables. Your body needs the nutrition and will be better off for it — even if you have to talk yourself into it the first few times.
What can a cash flow statement tell you about your business?
By identifying and recognizing patterns in your cash flow through regular analysis, you’ll be better able to predict or prevent challenges, like finding yourself low on cash right before running payroll or experiencing a negative cash flow when an invoice payment (due to your company) is running late.
If you see a cash flow gap coming, you can take measures like finding short- or long-term financing, working with a vendor to see if you can extend a payment timeline or, if necessary, adjusting labor costs.
When your cash flow is positive, you’ll also be in a better position to plan your growth by timing when you choose to act on a strategic decision, like purchasing new equipment, launching a new product or hiring more staff.
Understanding how your cash flow works gives you insights into the financial strength of your business. It tells you where you can improve and where to keep doing exactly what you’re doing.
If you’ve got a handle on your business’ financial health, it will be unmistakable to others wanting to do business with you as well. It’s sort of liking going into a job interview highly prepared rather than just winging it.
Is there an easy way to run and read a cash flow statement?
Yes, there is. When you use our free analytics and insights, they include a cash flow analysis. At ForwardAI Predict, our mission is “To empower businesses by enabling better, more affordable ways to improve financial health.” Offering a complimentary assessment that’s easy to read and understand is simply the first step in the many ways we aim help businesses take control of their finances.
If your company uses QuickBooks Online as its accounting software, you can start right now. Other integrations and innovations are coming soon.
This article is intended to be informational only and does not replace the expertise that comes from working with an accountant, bookkeeper or financial professional.
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