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Language of Cash Flow - Jun 29, 2010

Posted by: Kurt W. Altergott in Articles

You would think that a cash flow statement would be an easy read since you are dealing with real money and there are no estimates in the numbers. Yet, many managers find this statement difficult to understand. One reason is that the statement is divided into categories and these categories may take a while to understand and the labels used on the categories can be confusing. Another reason is that it can be difficult to see the relationship between the cash flow statement and the other financial statements.

The cash flow statement’s purpose is to show the cash moving into a business, termed inflows, and the cash moving out of the business, termed outflows. The statement is divided into three main categories.

Cash From or Used in Operating Activities

You may also see this category listed as “Cash Provided by or used for Operating Activities”. No matter what the exact language may be, the category includes all of the cash flow, both in and out, that is related to the actual operations of a business. It includes the cash received from customers and the cash paid out to vendors, employees for salaries, rents, and any other outflows made to keep the business operating.

Cash From or Used in Investing Activities

Please note that investing activities used in this statement refer to investments made by the company and not the owners. The most common example of an item in this category is cash spent on capital investments or long term assets. If a company purchases machinery which will benefit multiple periods, the cash it pays out will show up in this category. Conversely, if the company sells assets, the cash it receives will be shown in this category also.

Cash From or Used in Financing Activities

Financing activities refer to a company borrowing or paying back loans or transactions between a company and its shareholders. If a company receives proceeds from a loan or an equity investment from shareholders, the amounts would be shown in this category. Conversely, if the company repays a loan or pays dividends to shareholders, the cash paid out would show up here also.

There is a lot of useful information within the cash flow statement. The Operating category may be the single most important number indicating the health of a business. The Investing category may indicate how much cash the company is spending on its future or if it is treating the business as a “cash cow”. The Financing category may indicate how dependent the company is on outside financing if viewed over time.

But how does the cash reconcile with profit?

The cash flow statement starts with net profit for a reason. Assuming all transactions were done in cash and you exclude depreciation, etc. the profit would be the same as net cash flow. However, since every transaction is not completed in cash, we then determine which items on the income statement and the balance sheet had the effect of increasing or reducing cash. For example, let’s take a look at the change in accounts receivable in the current and prior balance sheet dates. The change in the balance may have increased $50 derived from sales on the income statement of $200 less cash collected of $150. The $50 difference or change is an adjustment to the profit to derive cash received for the period from operations.

This does involve some work and time invested to understand, so why is it important? Understanding your company’s cash situation will help you gain insight into what is going on in your business now, where the business may be headed taking into account past trends and future assumptions, and what senior management’s priorities need to be. You will better understand where your cash is coming from and how to best manage it in the future to attain your goals. It will generate many questions which need to be addressed and that is but one of the ways a B2B CFO^®can provide value.

At B2B CFO^®we concern ourselves with the client’s success and aspire for them to attain their goals and dreams.

Cash. We help you get it.