Financial Statements 101: Cash Flow is King

12 December 2016

This is part 3 of our 3 part series on financial statements.

The Statement of Cash Flows is one of three major financial statements in which is used as a tool by business owner’s to review their financial position and health of their company (The other two statements: Balance Sheet and Income statement)

The cash flow statement explains the cash inflows and outflows, and it will ultimately reveal the amount of cash a company has on hand. As we discuss the financial statements individually, it is important to note the relationship among the financial statements in entirety: by themselves, each financial statement only provides a portion of the story of a company's financial condition, where together, they provide a more complete picture.

Following the cash

The Cash Flow statement identifies the changes in certain balance sheet accounts and how the changes are categorized from cash activities. The statement format categorizes cash inflows and outflows in three specific activities: operating, investing and financing activities.

Operating - cash flow from operating activities indicates the money a company brings in from ongoing, regular business activities. This includes changes in working capital; such as increases or decreases in inventory, short term debt, and AR/AP. Cash Flow from operating activities can also be calculated by the following forumula:

(earnings before interest and tax) - taxes + depreciation

Comparing cash flow from operating activities to a company's EBITDA can give insight to how a company finances short term debt.

Investing - cash flow from investing activities indicates any cash change from any gains or losses from investments in the financial markets and business investments, such as property, plant and equipment. The cash flow from investing activities is one of the most important items on the statement, for it can be a substantial source or use of cash that significantly offsets any position or negative amounts of cash flow generated from operations.

Financing - cash flow from financing activities may appear to be very similar to cash flow from investing activities, so it's best to always reach out to your accountant for proper categorization. To finance such investments, the cash inflows and outflows would be a financing activity. Finance activities include the inflows of cash from investors, as well as the outflow of cash to shareholders as dividends as the company generates income. Other activities that would impact long-term liabilities would be noted as a financing activity, where short term would be operating.

A common understanding is that “Cash is King”; but analyzing your cash position, and identifying the cash impact, is the financial information needed to make informed decisions. To some people, cash is just a dollar figure, but to the informed reader, cash can tell a story. Understanding a cash position throughout all activities provides the reader of the financial statements with greater knowledge of the company's overall financial health.

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