Keeping your finances in check is the best thing that you can do for your business but it can also be very overwhelming at times. It is important that you can keep up with managing your finances especially if you’re running a small business such as your profit, revenue, and expenses.
A cash flow statement is a financial document that shows how cash flows in and out of your small business in a specific period. It indicates how your business is doing well since it often provides essential information such as your income while also providing you with information on your losses.
The cash flow statement allows business owners and investors to analyze and evaluate your profitable your business has become. This allows you to make important decisions moving forward. If you want to learn more about what exactly is a cash flow statement, check out the article below.
What is a Cash Flow Statement and Its Function in Business
A cash flow statement provides you with a summary of the movement of your cash in your business over a specific period. It tells you how much money you have made and how much you have lost for that period.
It is an essential tool for business owners to carefully manage their finances as it helps ensure that there is always cash or funds to meet the operational standards of the business.
It also ensures that you can invest in long-term assets, pay off your business-related debt, and even allow that money to return to the investors as profit.
A cash flow statement also helps you identify which areas in your business have too many unnecessary expenditures therefore you get to align your finances. You get to determine potential issues so you can act on them before it begins to affect your business.
How It Works
Cash flow statements work by providing you with financial information. Businesses often require cash flow statements depending on how much they need the information. Some need a monthly statement while others want to check it every quarter and large companies do it yearly.
It works by allowing you to identify which areas are causing you to lose your money while also pinpointing which areas in your business are making your profit. Think of it as an evaluation of how your business is going.
For example, you collect all the data within a single month through an inventory. You streamline all the information into a statement and it should show how much profit you have earned compared to the expenses that you have made for that month.
Classifying Different Cash Transactions in a Cash Flow Statement
When it comes to preparing a cash flow statement, you will need to identify three categories of cash transactions. These include operating activities, investing activities, and financing activities.
Operating activities are often the main source of the use of cash in your business operation. This can include revenue, taxes, interests, and expenses.
Meanwhile, investing activities are cash flows about long-term assets that you have invested in. These include property, equipment, and many other investments that you have made for the long term of your business.
Lastly, you have the financing activities which include debt. These three cash transactions play a huge role in your cash flow statement and the status of all three will help you determine the longevity of your business.
Calculating Your Cash Flow
There are two main methods for calculating your cash flow and these are the direct and indirect methods. All three cash transactions are calculated in both methods.
With the direct method, you list down all the cash receipts and payments from each transaction. This includes the receipts from sales made by the customers, cash that is paid to suppliers, cash paid to your workers as salaries, and many more.
The indirect method is geared toward the changes in your working capital, amortization, the gains and losses of your assets, and others. Both methods will provide you with all the information that you need to create your cash flow statement thus letting you determine which areas in your business are struggling and how you can improve it.
Differences Between a Cash Flow Statement and an Income Statement
Both cash flow and income statements play a critical role in your business’s performance. While they may all sound very similar and their functions might overlap each other, there are still quite a few differences between the two statements.
A cash flow statement is all about the movement of your cash in and out of your business while an income statement merely depicts the revenues, profits, losses, and expenses of your business.
Another difference is that a cash flow statement is based on the actual transaction made with cash while the income statement is based on records after they are earned whether or not cash is involved.
What Happens If There Is a Negative Cash Flow
This is the part where every business owner dreads to find in their cash flow statement – a negative cash flow. A negative cash flow happens when there is more expenses or outgoing cash than profit or earning or incoming cash that can fund the business.
This often happens when the sales are not enough to cover the costs of expenses. This means that you are currently operating at a loss since no cash is flowing into your business. This is where many business owners often decide to either cut costs or re-evaluate how they run their businesses.
While a negative cash flow is certainly an implication that there should be changes in your business, it does not always mean that your business is failing. It is actually very common in small businesses but if left unattended, it can be destructive to your business.
Conclusion
If you want to take full control of how you manage the finances of your business, a cash flow statement should be in order. It can help identify cash programs and potential problems in the future so you can easily prevent them from happening. Together with other documents like income statements, you can assess your earnings and make efficient and effective decisions in managing your business.