What is a Cash Flow Statement(CFS)?

A cash flow statement tracks the inflow and outflow of cash in an organisation or entity over a defined period, also known as the accounting period. It is an essential tool for managing finances, and denotes a business’ liquidity and its ability to fulfill its monetary commitments, including bills, salaries, eligibility for business loans, and repayment capacity. CFS is one of the three crucial reports for assessing a company’s performance along with the income statement and balance sheet.

Cash flow statements or CFS serve as a tool to delineate cash inflows from financial activities like business loans, investments and other operating activities. For cash outflows, it details costs incurred for business operations and investments incurred at a specific period of time. The cash flow statement provides managers with crucial information that helps them make well-informed decisions to efficiently manage and regulate their corporate operations.

Importance of Maintaining a Cash Flow Statement

In order for you as an organisations to fortify your place in the industry, it is advisable to maintain sufficient cash that enables you to apply for business loan, repay the debts already incurred and invest in commodities to maintain profitability. A business is declared bankrupt if it runs out of cash to repay its debts. A proper maintenance of CFSs offers you crucial insights into the financial stability and operational effectiveness of your business. Following are some of the key pointers that highlight the importance of maintaining a cash flow statement:

1. Liquidity Management: By keeping an eye on the incoming and outgoing cash activities specially new start-ups, SMEs and MSMEs, you can ensure your organisation has enough in hand to cover short-term obligations including payroll, supplier payments, and operating costs. In case of unfortunate crisis, it helps you to avoid falling in debt trap, eventually leading to business collapse.
2. Opens Doors to Future Prospects: Cash flow statement allows lenders and investors to assess your spending capacity, increasing your chances of securing loan for business easily. It allows the lender to assess your eligibility for business loans. It determines whether your organisation can generate enough cash to meet its financial obligations, including loan repayments. It allows interested parties to evaluate your business’ potential and how they can benefit from it in future by checking cash flow from operating activities.
3. Financial Planning and Budgeting: Through the analysis of past cash flow data, you can create more precise forecast and budgeting for your business that facilitates the effective allocation of resources. If there is excess cash lying around idle, you can use it for investments that can fetch profitable returns, for instance investing in shares and inventory. In case there is shortage of cash, your company can look for partners to invest in the business, enabling proactive measures and making of well-informed strategic decisions preventing the company from falling in liquidity.
4. Investment Decisions: Cash flow statements are used by creditors and investors to evaluate a company’s capacity to raise capital and pay off debt. While negative cash flow may raise questions about solvency and trustworthiness, positive cash flow signifies financial soundness and may draw investors.
5. Performance Evaluation: Businesses can assess their performance and pinpoint opportunities for development by comparing their current and forecast cash flows. It gives management information about how well operational plans are working and assists in making necessary adjustments.

Structure of CFS

There are three main components of a cash flow statement:

1. Operating Activities: The cash flows from the business’ main operations, including sales of products or services, supplier payments, payroll, taxes, and other operating costs, are reported in this area. It displays how much money is brought in or spent on the company’s main functions.
   Consider for example, a company named ABC records ₹100,000 in cash received from clients and ₹60,000 in cash paid for multitude of operations in a given year. The generated cash flow due to Operating Activities in that year comes out to be- ₹100,000 – ₹60,000 = ₹40,000.
   Operating activities are the culmination of all sources from where the business generated cash including receipts of loan, debts, equity and others.
    
2. Investing Activities: The cash flows associated with the acquisition or disposal of long-term assets, such as real estate, machinery, and equipment, as well as security investments, are reported in this area. It also covers mergers and acquisitions, financial flows from the sale of investments or from loans given to other organisations.
   For instance, the company ABC sells an outdated piece of equipment for ₹50,000 and spends ₹200,000 on a new manufacturing facility. From investing activities, the net cash flow is (₹200,000 – ₹50,000) = ₹150,000.

3. Financing Activities: The cash flows for the company’s financing activities, including the issuance and purchase of stock, the issuance and repayment of debt, and the distribution of dividends to shareholders, are recorded as financial activities.

Example: Business ABC issues bonds, collects ₹300,000 in cash revenues, and distributes ₹50,000 in dividends to shareholders. What’s left over after financing activities is ₹300,000 – ₹50,000 = ₹250,000.

Take a look at the following example to understand the structure of a cash flow statement better:
Table 1: Cash Flow Statement of Company ABC for FY Ended 31st Dec 2023

Types of Cash Flow

There are two types of cash flows in an organisation-

1. Positive: When a company has more cash on hand than it needs for a certain period of time, it is said to have positive cash flow. This excess might be saved for future costs, paid off debt, distributed as dividends to shareholders, or reinvested in the company. Positive cash flow is often regarded as an indication of sound financial standing since it shows that the company is making enough money to pay its bills and maybe expand.
2. Negative: Negative cash flow occurs when a company spends more money than it brings in over a specific time frame, leaving a financial shortfall. Due to this, the company might have to use its current cash reserves or rely on outside funding sources like loans or credit lines to pay for its expenses. Negative cash flow may also be a sign of impending difficulties with finances or inefficiencies in the company, such as excessive operating expenses, slow sales or excessive debts. Negative cash flow might be reason for alarm and necessitate taking proactive steps to resolve underlying problems and bring stability back to finances.

Methods of Calculating Cash Flow Statement

There are two methods used to calculate cash flow statement for a business:

Direct Method

• The direct method of calculating CFS involves directly documenting monetary transactions for operating activities. This covers cash receipts from clients, as well as cash payments to suppliers, staff, and operating expenses.
• This method segregates all cash inflows from outflows, giving a clear view of the cash flows created or used by operating operations.
  Indirect Method
• The indirect method uses the net income from the income statement and adjusts it for cash flows from operating activities.
• Non-cash expenses, such as depreciation, changes in working capital items like accounts receivable, payable, and inventory, are added or deducted from net income to calculate cash flows from operations.
• This method reconciles net income with cash flows from operating activities and is widely utilized by businesses due to its simplicity.

Concluding Remarks

Cash flow statements are an important financial document for any organisation that helps determine their business loan eligibility. Positive cash flow and enhanced operating costs presents an organization as a deserving candidate and increases their chances of business loan procurement. FinTech organisations like FlexiLoans offers competitive loan for businesses with limited credit history and limited collateral resources.

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