Statement of Cash Flows

The statement of cash flows is the last of the three main financial statements. It summarises the movement of cash and cash equivalents within a company. The statement measures a business manages its cash, including how well it generates cash to cover its operating expenses and repay its debts. There are two ways of calculating cash flow, either using the direct or indirect method. There are three main components of a statement of cash flows – Operating activities, investing activities and financing activities.

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Importance of a Statement of Cash Flows

Cash flow is important for any business and to be successful a business needs to have sufficient cash at all times. A business will be declared bankrupt if it doesn’t have enough cash to pay its bills and suppliers. The report can provide a few benefits to a business, including:

• can provide details about spending
• can help maintain cash balances at an optimum level
• can help focus on generating cash
• can be very useful for short-term planning

How is the Statement of Cash flows Structured?

As mentioned above there are three main sections.

Cash from Operating Activities

The operating activities section includes how much cash has been generated from a business’s products or services. Which may include any of the following:

• Sales of products or services
• Interest payments
• payments for products or services purchased by the business
• Salary and wages paid to staff
• Rent payments
• other operating expenses

Cash from Investing Activities

The investing activities section includes the sale and purchase of assets and loans made to suppliers or received from customers. Sometimes a business can experience negative cash flow especially if they heavily invest in fixed assets. This is not always an indication of the business performing poorly as it may lead to high growth within the company.

Cash from Financing Activities

The financing section includes cash from investors and banks, dividend payments to shareholders, payments for stock repurchases and loan principal payments.

What is the difference between the Direct and Indirect Methods? Is one method better than the other?

The difference lies in how the cash in and out is determined.

The Direct Method uses actual cash in and out which uses known amounts. The statement is reported using a straightforward calculation method using cash payments and receipts.

The Indirect Method begins using the net income or loss from the P&L Report, then modifies the amount using balance sheet account increases and decreases.

Neither calculation method is better or worse than the other. Using the indirect method can provide a way of reconciling items on the balance sheet to the net income or loss on the P&L report. The statement of Cash Flows report that is available in Xero is calculated using the Direct Method as the software works off the reconciled transactions within the software.

What is Negative Cash Flow?

Negative cash flow is when a business has more expenses than incoming cash. This can happen if the sales that a business is making is less than the expenses that they are incurring. As you can see above in the Cash flow example from Xero the 2022 year shows a negative cash flow which can be easily seen by the sales being less than half of the payments to suppliers and employees. Negative cash flow can be quite common for small businesses or new businesses, having a negative cash flow trend for a long period of time can be unhealthy for a business and stressful for the owners as they will need to prop the business up with their own cash.

A Cash flow statement can be a useful report for a business, as it will quickly show you if the business has enough cash to pay its bills and invest in assets for future growth. You won’t be able to just assess a business by viewing this report, you also need to look at the Profit & Loss report and Balance sheet to get a clear view of how the business is doing. For more information on the statement of cash flow check out business.govt.nz which has a sample of a statement and how to read them.

Remember to check out our next article on Cash Flow apps and also one of our other articles on Float app.