UNDERSTANDING THE CASH FLOW STATEMENT

Cash flow, as the name implies, is the movement of funds/cash in and out of a business, project, venture or individual. It has to do with all the movement of funds and measured over a period of time. It highlights the value or the situation of an individual, business or a project. It also determines the liquidity (measures the ability to meet maturing obligations as they fall due), viability and sustainability. In essence, it measures the availability of cash/revenue to finance your needs.

It is used to test the ability to remain a going concern. The Cash flow must be positive, sufficient to meet capital expenditure, pay returns to financiers and can stand the test of time. Being rich does not necessarily mean liquid. The riches might be in assets that are not easily convertible to cash.

CASH FLOW STATEMENT

This is arguably the most important financial statement that a company (whether publicly quoted or one man business) or project prepares or need to prepare. It traces and measures the flow of funds in and out of the business/project during a period (monthly, quarterly, bi-annually or annually). It helps determine the timing, amount and predictability of future cash flows. The statement is used to highlight where and how the revenue/cash is being generated and where it went or how it was spent.

It is used to compliment other financial or accounting books such as income statement (Profit & Loss Account) and the Balance Sheet. Income Statement, simply put, is a record of sales, income, expenses and profitability of a company or business for a given period. Income is the reward of a business activity. Balance Sheet (also known as Statement of Financial Position) on the other hand, shows the state of a Company at a particular date in time and the assets are arranged based on liquidity.

To avoid complexity and simplify the understanding of the importance of Cash flow statement, the focus will be on the direct method which reports major classes of gross cash receipt and payments; inflows and outflows of funds. The implication of changes in cash and cash equivalent of the assets on the Cash flow statement during the period of review will however be discussed in subsequent reviews.

FOCUS

1.     Operating Cash flow

Refers to the core function of a business or project and the revenue/cash generating ability in contrast to how the revenue/cash was expended on the daily activity from producing a product or service. The activities include:

·           Sale of a product or service

·           Interest on investment or dividend

·           Collections

·           Payment: suppliers, salaries, interests, taxes, etc.

·           Overheads incurred in the daily operation

2.     Investing Cash flow

Focuses on the revenue/cash generated and expended on other activities outside the core operation and growth potentials for the business/project. It shows how the excess liquidity generated from the core activity is utilized. It usually involves buying and selling of assets that has potential for generating future Cash flow, such as

·        Purchase and/or sale of assets

·        Purchase and/or sale of shares

·        Lending/loans

3.     Financing Cash flow

Shows how the business was financed over the period under review. It involves borrowings, repayments/refund of borrowings or loans, issuance of stock or payment of dividend. It involves securing sufficient funds to finance 1 & 2 with a view of repaying same or dividends over a period or at a future date. Such activities include:

·        Funds to finance working capital

·        Funds/loans to finance productive assets needed for the daily operation.

In my next post, the interpretation of the three focal points mentioned above will be reviewed.

Please send your mail to Michael@bizadvisory.tk for further information and inquires or request for assistance/advice in developing and managing your Cash flow.