One of the most helpful tools for a business owner is cash flow reporting. This article will provide basic instructions on how to read cash flow statements. The different sections and presentation can get a little confusing to pin point exactly where the cash is coming from or going. There are two different presentations of cash flow statements: direct and indirect. Most of the time you see the indirect method being used in company financials, but they both show the same information just in a different format.
The indirect cash flow starts with the beginning balance adds the Net Income for the period (less non-cash transaction such as depreciation) and then adds and subtracts the net changes in all the balance sheet accounts. This gives us the cash balance. The direct Cash Flow, on the other hand, shows sources that add cash through collections and subtracts cash expenditures. The collections and expenditures are split amongst the three different sections of the cash flow statement: operating, investing, and financing as are the accounts on the direct cash flow.
Cash Flow from Operating Activities includes everything that has to do with operations. Net Income is included in this section. In an indirect cash flow, the accounts included are things like accounts receivable, accounts payable, prepaid expenses, and deferred revenue. When the accounts receivable balance decreases, cash increases because that indicates that you collected more than you added to the account. When you are adding to your AR balance, you are providing services without collecting cash. In a direct cash flow, the categories are things like cash collections from customers, payments to employees, and payments to vendors.
The investing section includes anything that you spend cash on to invest in the long term viability of a company. This is where cash expenditures on things like buildings, computers, equipment, and other fixed assets that are capitalized. Investments in other stock or another company are also included in this section. All these items are usually bigger expenditures for things that don’t necessarily show up on an Income Statement. They are investments in company assets.
The financing section represents how you are financing your company. Financing activities include things like contributions from owners, sale of stock, loans, a line of credit. Any funding of the business outside of normal operations is considered a financing activity. Payments on any of these items are also included in financing, but any interest paid as a result of the financing is considered an operating expense. Again, the items that are included in this section are usually not found on the Income Statement.
The two types of cash flow statements have some different benefits. The direct statement may be a little easier to follow as it says “Cash Collections from” and “Payments to”. However, it may take more calculations to create. The indirect statement may take a little more to read and analyze, but it’s much easier to create. It also doesn’t jump back and forth between Income Statement and Balance Sheet. It encompasses the Income Statement on one line and then analyzes your balance sheet accounts. Both come up with the same result and help you understand your cash balances.Written by: Ashley Peth TGG Accounting