The statement of cash flows
is one of the four basic financial statements. This schedule shows the sources
of your cash- and how you use cash.
The importance of cash flows
Understanding the statement
is important. Many businesses fail because they don’t have sufficient cash to
operate. If you increase sales- but don’t increase collections on those sales-
your available cash balance will decrease. Why?
Well, you’re spending more money
to produce more products and services to meet the higher sales demand. You need
to collect cash on those higher sales to replenish your cash balance. If not,
you won’t have enough cash to make your product or service going forward. If you can’t
raise additional cash (through issuing debt or equity), you can’t operate your
business.
Reviewing the checkbook: 3 activities of the
cash flow statement
When you put together a
statement of cash flows, you start by opening your checkbook. You review your
transactions (deposits, checks written, automatic debits), and assign them to
one of 3 activities:
1.
Investing:
This category represents buying and selling assets. When you buy a vehicle,
that’s a use of (decrease in) cash. Selling a building you own is a source of (increase
in) cash.
2.
Financing: There are two ways to
raise money to run your business: debt and equity. Financing refers to raising money to run your business- and paying it back. Issuing stock is a source of
(increase in) cash. Paying off a bank loan is a use of (decrease in) cash.
3.
Operations: I suggest that you review your checkbook and
identify the investing and financing activities first. Everything
else is in the operations category. So, collecting money from clients
and buying materials is an operating activity. Operations represent the day-to-day
business activities. You’ll find that most of your checkbook
transactions will be operating activities.
Cash flow changes vs. cash in the balance
sheet
One more step before you put
your cash flow statement together. Take a look at the change in your cash
account in the balance sheet. Here’s an example:
Cash balance,
12/31/X1 $1,000
Cash
balance, 12/31/X2 $1,200
Change in
cash $200
Your
net change in cash on the statement of cash flows should agree to the
change in cash listed above. When you compile the sources and uses of cash for
the three activities, the total change in cash should also be $200. If not, you’ve
made a mistake. That mistake may be in the balance sheet or the cash flow
statement- you’ll have to do some digging to find out.
Cash flow statement format:
Finally, your cash flow
statement will look something like this:
Cash flow
from operations $1,000
Cash flow
from financing ($1,200)
Cash flow
from investing $400
Net increase
(decrease)
in cash $200
I’ll
go into more detail on cash flows in future blogs. In the meantime, here’s a
video that you might find helpful:
Your
comments are welcome! For live chats on some of the toughest accounting topics, go to my website listed below.
Thanks!
Ken Boyd
St. Louis Test Preparation
(cell) (314) 913-6529
(you
tube channel) kenboydstl
(blog) http://accountingaccidentally.blogspot.com/
(twitter)
@StLouisTestPrep
Author/ Cost Accounting for Dummies (John Wiley and Sons) March 2013
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