The cash flow statement, also known as the statement of cash flows, allows a business to stop in time and take a snapshot of the company’s ability to generate cash. Even thought the income statement is an important financial report to show profitability, it does not show a true picture of the company’s ability to generate ready cash. The statement of cash flows can be completed monthly, quarterly or yearly.
Understanding the Cash Flow Statement
Almost every small business sells a product or service that doesn’t generate immediate cash. The accounts receivable general ledger and subsidiary ledgers usually control sales that don’t generate immediate money. If a business has a large portion of its revenues in accounts receivables with a slow turnover rate, it could have a detrimental affect on cash flow.
Accounts payable also has an affect on a company’s ability to generate ready money. When the money comes due and a payment on account is made, it’ll have a negative affect on cash flow. If the purchase was for an asset, the actual transaction may not have an affect on profits, but will certainly have an affect on cash.
As an example if to much inventory is purchased, it will affect the balance sheet but not the income statement. Let’s see how the actually transaction would play out.
Inventory purchase
- Inventory - $50,000 - debit
- Accounts payable - $50,000 - credit
Payment made on account 30 days later
- Accounts payable - $50,000 - debit
- Cash - $50,000 – credit
This example illustrates that no income account was affected, thus profit was not affected. Every general ledger account for the purchase of inventory only affected the balance sheet, yet cash was decreased by $50,000.
The Income Statement and Balance Sheet’s Relationship to Cash Flow
As evident by the above example, balance sheet accounts will have an affect on cash flow. Naturally the income statement also has an affect. Businesses primary means of generating money is through the sales of a product or service, this is known as operational activities. There are also other methods of generating money like investment and financial activities. For the purpose of understanding the cash flow statement, the primary focus will be on operational activities.
Sample Statement of Cash Flows – Direct Method
The following sample is a simplistic example of the direct method.
Cash Flow Statement Operating Activities August 31, 2010
- Cash sales receipts $7.000
- Cash receipts from accounts receivable $40,000
- Cash paid from petty cash ($3,000)
- Cash paid from accounts payable ($27,000)
- Cash paid payroll ($10,000)
- Cash paid income taxes ($5,000)
- Net increase in cash $2,000
- Cash beginning of month $5,000
- Cash end of month $7,000
The three financial statements, balance sheet, income statement and statement of cash flows are important to get a true picture of the performance of any business. The balance sheet shows the business' net worth, the income statement shows the profitability and the cash flow statement the business' ability to handle money.
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