The three standard statements of most financial packages include the Balance Sheet, the Income or Profit & Loss (“P&L”) Statement, and the Cash Flow Statement. The P&L is often considered the most important and relevant statement by most owners, managers, and analysts, however, the astute accountant can make a strong argument about why the Balance Sheet is really the most important statement of the three. And then there is the Cash Flow Statement, often overlooked, usually misunderstood and skimmed over with a fleeting glance, but a very critical and integral part of the financial statements. The Cash Flow Statement is the “new kid on the block” that was first required on the financial statements of public companies in 1988, but is an integral part of financial reporting that ties the other reports together for a complete picture of a company’s financial health. It tells owners and other financial statement users one very important thing – how much cash the company generates.
The Cash Flow Presentation
A company can choose to use the direct method or indirect method of presenting the cash flow, however both methods provide the same general synopsis. How much cash the company started the period with, how the company spent its cash, how the company received its cash, and the ending cash balance available for future investment or distribution to owners. As you can see these are some very important issues.
The three common classifications on Cash Flow Statements include cash provided or used in:
Operating Activities – Revenue-generating activities of the business entity, they include cash effects of transactions by which net profit or loss is determined.
Investing Activities – Typically activities involving the acquisition and sale of fixed assets (i.e. and, building and equipment) but can also include stocks and other investments if not held for resale as a primary business activity.
Financing Activities – Activities which change the size and the composition of owners’ capital or changes in debt. (i.e. contributions, distributions, stock issuance and purchase, and debt).
The Cash Flow Importance
Cash can come from both internal and external sources, and the Statement of Cash Flow helps companies and investors separate and observe the differences and extent of the cash inflows and outflows. Internal, as opposed to external cash sources, provide a company with successful attributes and assurances that include:
1) preventing and monitoring company debt
2) preventing unnecessary expenditures from interest, late payment penalties and debt costs
3) ensuring timely investment and cash available for investment opportunities
4) ensuring timely payment of expenses and debts
5) and most importantly – ensuring a level of regular business income without relying on outside investment or cash borrowing.
Effectively managing and monitoring cash flows serves many purposes. The most significant reason is to provide owners and managers insight into the company’s cash position. This knowledge better equips management to make informed decisions about regular business operations, the need for further investment in the business, and capital from equity or debt partners. Cash management is something most businesses of all sizes struggle to perfect. While the Cash Flow Statement is by no means the only method of monitoring cash flows, it is an integral part of the reporting statements and should not be overlooked by the financial statement users.Written by: Brian O’Connor TGG Accounting