The Statement of Cash Flows (SOCF) is one of the big three financial reports. The Balance Sheet, Income Statement and the Statement of Cash Flows should be studied each month. Like the Income Statement, The Statement of Cash Flows depicts performance during a specific period of time as opposed to the balance sheet which is a snapshot of what is going on with the business at a specific point in time.
You might be wondering why we are looking at both the Income Statement and the Statement of Cash Flows.They seem similar in nature, however, they look at business finances from two different perspectives. The Income Statement is on the accrual basis of accounting. The income and expenses have been incurred, but may or may not have been received or paid out. The Statement of Cash Flows, on the other hand, is reported using the cash basis of accounting. This report will give a picture of how the cash is actually flowing through the business.
When comparing the two statements you will want to look at the net income versus the cash flow. If the cash flow is greater than the net income this is a positive for the business. If, on the other hand, the cash flow is less than the net income, this is bad for business and is unsustainable. In case you are wondering, it is almost impossible for the two to be equal in value.
You are looking for trends here. There will be months in your business where the net income is less than the cash flow. It may just be the way the numbers happened to line up that month. If this becomes a trend, however, and stays this way, changes in the business should be made to get this turned around. The overall goal here is to keep the cash flow greater than the net income.
The SOCF is broken down into three different areas. We will be looking at cash flow through the operating activities, investing activities and financing activities. The balance sheet and income statement break the information down in the types of accounts.
Operating activities are presented first on the statement. These are the income and expenses directly related to the operations of the business. The income and expenses are converted from the accrual basis to the cash basis.
Investing activities are the items related to the investments within the business. These could be the buying or selling of long term investments not related to business. More likely these would be the purchase and sale of property, land, equipment etc.
Financing activities are related to the the paying out of dividends to stockholders within a business. These could also be buying and selling of the company’s own stock or membership interest, but this is less common.
If you are studying the Statement of Cash Flows and find something that you would like to change, keep in mind, when any asset (except cash) increases, the cash flow decreases. Likewise, when a liability or equity account increases, cash flow increases The inverse is also true.
Looking over assets and liabilities will help you pinpoint areas in your business that could change to increase cash flow as well as show you areas where cash could be used to benefit your business. Understanding how these activities affect cash flow could be of major benefit to your business.
The Statement of Cash Flows is one of the more difficult statements to understand within the three reports. It is however one of the most important in a business. Cash is king when it comes to business and without it, no business is sustainable.