In this article, we will provide a comprehensive guide on how to create a cash flow statement in a well-structured. We will begin by defining what is cash flow statement, followed by an in-depth explanation of its key components. To enhance understanding, we will illustrate each section with practical examples, offering valuable insights into its preparation and significance.
Table of Contents
- What is Cash Flow Statement?
- Why Do Companies Prepare a Cash Flow Statement?
- Structure of Cash Flow Statement
- Parts of the Cash Flow Statement (Explained)
- Summary
- Why Does Preparing a Cash Flow Statement Matter?
- Key Takeaway
A cash flow statement is like a company’s financial diary. It tracks how much cash comes in and goes out during a specific period. Unlike other financial reports like the income statement or balance sheet, the cash flow statement focuses solely on cash. This is important because, in the business world, “cash is king.”
Let’s explain the concept step by step, using Allied Food Products as an example.
What is Cash Flow Statement?
The cash flow statement is a financial report that shows where a company’s cash comes from (inflows) and where it is spent (outflows). It’s divided into three main parts:
- Operating Activities – Day-to-day business operations.
- Investing Activities – Buying or selling long-term assets.
- Financing Activities – Borrowing or repaying money, or paying dividends.
At the end of the report, it summarizes the company’s overall cash change and its final cash balance.
Why Do Companies Prepare a Cash Flow Statement?
A cash flow statement is essential because:
- It helps businesses understand if they have enough cash to meet their needs.
- It shows how well the company generates cash from its core activities.
- It helps investors and managers assess whether the company is financially healthy.
Imagine running a café. Even if your café is profitable on paper, you could run into trouble if customers delay payments, or if you spend all your money on equipment and can’t pay bills. The cash flow statement helps prevent these surprises by keeping an eye on actual cash.
Structure of Cash Flow Statement
We have used the cash flow statement example for the company named Allied Food Products for the year 2021. To help you understand more easily.
Parts of the Cash Flow Statement (Explained)
1. Operating Activities on Cash Flow Statement
This section of operating activities on the cash flow statement focuses on cash from the company’s main business operations. It starts with net income (profit) and adjusts for non-cash expenses and changes in working capital.
Let’s explain the part of operational activities in the statement of cash flow of Allied Food Products:
- Net Income ($146.3M): This is the profit reported on the income statement. But net income doesn’t mean cash. Why? Because it includes things like credit sales (money not yet received) and non-cash expenses like depreciation.
- Depreciation and Amortization ($100M): Depreciation is the gradual cost of using assets (like machinery). It’s an expense on paper but doesn’t involve actual cash. So, we add it back to calculate cash flow.
- Increase in Inventories (-$200M): Allied spent $200M on more inventory (products to sell). This used up cash, so it’s a negative entry.
- Increase in Accounts Receivable (-$60M): Allied made sales on credit, meaning customers haven’t paid yet. This ties up cash and is also a negative entry.
- Increase in Accounts Payable ($30M): Accounts payable is money Allied owes suppliers. By delaying payments, the company saved $30M in cash, making this a positive entry.
- Increase in Accrued Wages and Taxes ($10M): Allied delayed paying wages and taxes, effectively borrowing $10M from employees and the government. This is a positive cash inflow.
Net Cash from Operating Activities ($26.3M): After adjusting for all the above, Allied generated $26.3M in cash from its operations.
Let’s Look at Another Example in Real Life: Imagine your café made 10,000 in profit this month. You spent 2,000 dollars buying extra coffee beans (inventory), and 1,000 dollars is still owed by customers (accounts receivable). However, you delayed 500 dollars in supplier payments (accounts payable). After adjustments, you might have only 7,500 dollars in cash.
2. Investing Activities on Cash Flow Statement
The section on investing activities on the cash flow statement looks at cash spent or earned from buying or selling long-term assets like property or equipment.
Let’s explain the part of investing activities on the cash flow statement of Allied Food Products:
- Additions to Property, Plant, and Equipment (-$230M): Allied spent $230M on new fixed assets. This is a big cash outflow. If Allied had sold some equipment instead, it would be recorded as a cash inflow.
- Net Cash from Investing Activities (-$230M): Since Allied didn’t sell any assets, this section shows only the outflow of $230M.
Example in Real Life: Your café decides to buy a fancy espresso machine for 2,000 dollars. That’s a cash outflow in the investing section. If you sold your old machine for 500 dollars, that would be a cash inflow.
3. Financing Activities on Cash Flow Statement
The section on financing activities on the cash flow statement records how the company raises funds (borrowing) or returns money to investors (paying dividends).
- Increase in Notes Payable ($50M): Allied borrowed $50M from the bank, which brought in cash.
- Increase in Bonds ($170M): Allied issued bonds (long-term debt), bringing in another $170M in cash.
- Payment of Dividends (-$86.3M): The company paid $86.3M in dividends to its shareholders, reducing cash.
Net Cash from Financing Activities ($133.8M): After accounting for all inflows and outflows, Allied generated $133.8M in cash from financing activities.
Example in Real Life: Your café takes out a 10,000 dollars loan from the bank (inflow). You also pay 2,000 dollars to investors (outflow). Your net cash from financing is $8,000.
Summary
This section ties everything together and shows how the company’s cash balance changed over the year.
- Net Decrease in Cash (-$70M): Allied’s cash outflows for investing (-230M) dollars outweighed the inflows from operations (+26.3M) dollars and financing (+133.8M) dollars, leading to a 70M dollars cash decrease.
- Cash at the Beginning of the Year ($80M): Allied started the year with 80M dollars in cash.
- Cash at End of the Year ($10M): After the 70M dollars decrease, Allied ended the year with just 10M dollars.
Why Does Preparing a Cash Flow Statement Matter?
By preparing a cash flow statement a company can figure out many things. Like, Allied Food Products’ cash flow statement reveals some challenges:
- Low Operating Cash Flow: The company isn’t generating enough cash from its core business.
- Heavy Investment Spending: It’s spending a lot on new equipment, which could strain finances if operating cash doesn’t improve.
- Dependence on Borrowing: Allied had to borrow heavily to fund its activities.
For Allied to stay financially healthy, it must:
- Generate more cash from operations.
- Balance its investments with its cash-generating ability.
- Avoid relying too much on borrowing.
Key Takeaway
A cash flow statement is a powerful tool to understand a company’s financial health. By looking at Allied’s example, you can see how cash flows through a business, where it’s spent, and how much is left at the end of the day. It’s not just about profits—it’s about managing cash wisely to ensure long-term success.