Understanding the Cash Flow Statement

A cash flow statement is an important financial document for any business. It offers insight into cash inflows and outflows and provides a clear picture of a company's liquidity and overall financial health.

This guide will explain the components of a cash flow statement, its importance, and how it can benefit your business.

Understanding the Cash Flow Statement

The cash flow statement is divided into three main sections:

Operating Activities

The operating activities section of a cash flow statement captures the cash generated or used by a company's core business operations. This section reflects the day-to-day transactions that affect the company's cash flow. Here are some key elements included in operating activities:

Cash Receipts from Sales of Goods and Services: This represents the money received from customers for products sold or services provided. It is the primary source of cash inflow for most businesses.

Cash Payments to Suppliers: This includes the cash paid for raw materials, inventory, and other supplies needed to produce goods or offer services. Timely supplier payments are crucial to maintaining good relationships and ensuring continuous operations.

Cash Payments to Employees: Salaries, wages, bonuses, and other employee benefits fall under this category. Employee compensation is a significant cash outflow that needs careful management to maintain operational efficiency.

Other Operational Expenses: These are other cash payments required for daily business activities, such as utilities, rent, insurance, and office supplies. Effective management of these expenses is essential for maintaining a healthy cash flow.

Adjustments for Non-Cash Items: Depreciation, amortization, and other non-cash expenses are added back to net income because they do not involve actual cash transactions. Changes in working capital, such as accounts receivable, accounts payable, and inventory, are also adjusted in this section.

Investing Activities

The investing activities section of a cash flow statement covers cash transactions related to the acquisition and disposal of long-term assets and investments. This section reflects a company's growth initiatives and its approach to managing its investment portfolio. Key elements include:

Purchase of Property, Plant, and Equipment (PPE): This includes cash spent on acquiring or upgrading physical assets like buildings, machinery, and technology. These investments are crucial for long-term growth and operational efficiency.

Proceeds from Sale of Assets: When a company sells off its assets, such as old equipment or property, the cash received from these sales is recorded here. Selling non-essential assets can generate cash that can be reinvested in more productive areas.

Investments in Securities: Cash spent on purchasing stocks, bonds, or other financial instruments falls under this category. Conversely, cash received from selling these investments is also recorded here.

Loans Made to Other Entities: The cash outflow is recorded in this section if a company lends money to other businesses or individuals. Repayments received from these loans are also included here.

Financing Activities

The financing activities section of a cash flow statement details the cash movements related to funding the business. It explains how a company raises capital and repays its financial obligations. Key elements include:

Issuance of Equity: Cash received from issuing new shares of stock is recorded here. This is a common way for companies to raise capital for expansion or other significant expenditures.

Borrowing and Repayment of Loans: This includes cash inflows from taking out loans or issuing bonds and cash outflows for repaying these financial obligations. Managing debt effectively is crucial for maintaining a healthy balance sheet.

Dividend Payments: Cash paid out to shareholders as dividends is recorded in this section. Dividends represent a return of profits to shareholders and are an essential factor in retaining investor confidence.

Repurchase of Company Stock: If a company buys back its own shares, the cash spent is recorded here. Stock repurchases can be a way to return value to shareholders and manage the company's capital structure.

Why a Cash Flow Statement Matters

A cash flow statement is not just a mandatory financial report; it is a tool that helps business owners, investors, and stakeholders make informed decisions. Here’s why it is essential:

Liquidity Management: By understanding cash inflows and outflows, businesses can manage their liquidity more effectively, ensuring they have enough cash to meet short-term obligations.

Investment Decisions: The cash flow statement reveals how much cash is being invested in the business and whether these investments are generating returns. This information is vital for making strategic investment decisions.

Funding and Financing: This statement helps in assessing the company’s ability to secure financing and repay debts. It shows how well the company can generate cash from its operations to fund growth and pay dividends.

Performance Evaluation: Unlike the income statement, which can include non-cash items, the cash flow statement provides a clearer picture of actual cash generated. This helps in evaluating the true financial performance of the business.

Creating a Cash Flow Statement: Detailed Steps

Creating a cash flow statement involves several steps to reflect the financial activities of a business accurately. Here’s a detailed explanation of each section and how to calculate the cash flows:

1. Calculate Cash from Operating Activities

Operating activities reflect the core business operations that generate revenue and incur expenses. The steps to calculate cash from operating activities are:

Start with Net Income: Begin with the net income figure from the income statement. Net income includes all revenue and expenses, but some of these items do not affect cash directly.

Add Back Non-Cash Expenses: Adjust for non-cash expenses such as depreciation and amortization. These expenses reduce net income but do not involve actual cash outflows. Adding them back gives a clearer picture of cash generated from operations.

2. Adjust for Changes in Working Capital

By adjusting for these working capital changes, you can determine the actual cash generated or used by the company’s core operations.

Accounts Receivable: If accounts receivable increase, it means not all sales have been collected in cash, reducing cash flow. If they decrease, it indicates cash has been collected from previous sales, increasing cash flow.

Accounts Payable: An increase in accounts payable means the company has not yet paid all its bills, which preserves cash. A decrease suggests that cash has been used to settle debts, reducing cash flow.

Inventory: An increase in inventory signifies cash outflow as the company has purchased more goods than it sold. A decrease indicates that inventory has been sold, contributing to cash inflow.

3. Determine Cash from Investing Activities

Investing activities pertain to transactions involving long-term assets and investments. To calculate cash from investing activities:

Record Cash Spent on Purchasing Assets: Document cash outflows for acquiring long-term assets such as property, plant, and equipment (PPE). These investments are necessary for growth but require significant cash outlay.

Record Cash Received from Selling Assets: Include cash inflows from the sale of assets. Selling non-essential or outdated assets can generate cash that can be reinvested or used for other operational needs.

Include Transactions Related to Investments:

Purchase of Securities: Cash spent on buying stocks, bonds, or other financial instruments is recorded as an outflow.

Proceeds from Sale of Investments: Cash received from selling securities is recorded as an inflow. By accounting for these transactions, you get a clear picture of how cash is being used for growth and investment purposes.

4. Evaluate Cash from Financing Activities

Financing activities involve transactions that affect the company’s capital structure. To calculate cash from financing activities:

Document Cash Inflows from Issuing Stock or Taking Loans:

Issuance of Equity: Record the cash received from issuing new shares of stock. This provides capital without incurring debt.

Borrowing: Include cash inflows from taking out loans or issuing bonds. This funding can be used for expansion, operations, or other purposes. Document Cash Outflows from Repaying Loans and Paying Dividends:

Loan Repayments: Record the cash outflows for repaying borrowed funds. This reduces liabilities but requires cash outflow.

Dividends: Include the cash paid out to shareholders as dividends. This is a return of profit to investors but decreases the company’s cash reserves.

Stock Repurchases: If the company buys back its own shares, record this as a cash outflow. These activities show how the company is financed and how it returns value to its shareholders.

5. Combine the Sections

To determine the net increase or decrease in cash for the period, sum the cash flows from all three activities:

Operating Activities: Calculate the total cash generated or used by the core business operations. Investing Activities: Determine the net cash spent on or received from investments.

Financing Activities: Sum the cash inflows and outflows related to funding the business.

Net Increase/Decrease in Cash = Cash from Operating Activities + Cash from Investing Activities + Cash from Financing Activities.

This final figure represents the net change in the company’s cash position over the period. A positive number indicates an increase in cash, while a negative number signifies a decrease.

Best Practices for Managing Cash Flow

Effective cash flow management is vital for the financial health and stability of any business. Here are some expanded strategies to ensure your business maintains a healthy cash flow:

Monitor Regularly

Regular monitoring of your cash flow statement is crucial. By reviewing your cash flow monthly, you can:

Identify Trends: Detect patterns in your cash inflows and outflows, helping you understand seasonal fluctuations and other trends that affect your cash position.

Spot Issues Early: Quickly identify potential cash flow problems, such as increasing receivables or unexpected expenses, and take corrective action before they escalate.

Make Informed Decisions: Use up-to-date cash flow data to make better business decisions, such as timing for new investments, hiring, or other significant expenses.

Optimize Receivables and Payables

Managing your receivables and payables efficiently can significantly improve your cash flow: Accelerate Receivables: Implement strategies to get paid faster. This can include offering early payment discounts, sending timely invoices, and following up on overdue accounts promptly. Using automated invoicing systems can also reduce delays.

Delay Payables: Extend your payment terms with suppliers when possible, but avoid incurring late fees or damaging relationships. Negotiate favorable terms that align with your cash flow cycle to ensure you maintain a positive cash balance.

Monitor Credit Policies: Regularly review your credit policies to ensure they are not too lenient. Conduct credit checks on new customers to reduce the risk of bad debts.

Control Expenses

Keeping a tight rein on expenses is essential for maintaining a positive cash flow:

Regular Review Expenses: Conduct periodic reviews of your expenses to identify areas for cost savings. Look for non-essential expenditures or opportunities to negotiate better rates with suppliers.

Implement Budget Controls: Establish budgets for different departments or projects and monitor adherence to these budgets. This helps prevent overspending and ensures funds are used efficiently.

Embrace Cost-Saving Technologies: Invest in technology and automation to reduce operational costs in the long run. For example, switching to energy-efficient equipment or using software to streamline administrative tasks.

Plan for the Future

Proactive planning can help you anticipate cash flow needs and avoid shortages:

Cash Flow Projections: Develop cash flow projections based on historical data and future expectations. This helps you foresee periods of cash surplus or shortage and plan accordingly.

Scenario Planning: Create different scenarios (best case, worst case, and most likely case) to prepare for various financial situations. This allows you to develop contingency plans and remain flexible.

Maintain a Cash Reserve: Build and maintain a cash reserve to cushion against unexpected expenses or revenue downturns. This reserve can provide a safety net during tough times.

Secure Financing in Advance: Establish lines of credit or other financing options before you need them. These resources can help you manage cash flow gaps without the stress of scrambling for funds at the last minute.

How Navan Can Help

Navan offers innovative solutions that streamline business travel and expense management, which can play a crucial role in optimizing your cash flow. By using Navan, businesses can:

Automate Expense Reporting: Simplify and accelerate the expense reporting process, reducing administrative burden and ensuring timely reimbursements.

Gain Better Visibility: Access real-time data and analytics on travel and expense spending, enabling better budgeting and expense control.

Ensure Compliance: Implement policies and controls to ensure that all travel and expense activities comply with company guidelines, reducing the risk of overspending.

Understanding and managing your cash flow statement is fundamental for your business's financial success. By keeping track of cash inflows and outflows, making informed investment decisions, and optimizing expenses, you can ensure your business remains financially robust.

Navan's solutions can help you achieve these goals, making cash flow management more efficient and effective. Watch a 2-minute demo with Navan today.