By: Stewart Brannen        

Perhaps one of the most useful and beneficial financial statements that a business can rely upon is its statement of cash flows.  This statement depicts the movement of money (cash) in and out of a business, and it is the best measurement of determining how much cash is available at any one point in time.  Financial analysts, accounts and business turn around specialists always turn to the statement of cash flows to determine the financial viability of a business.  Generally speaking, businesses that keep good records and that are on top of their cash flow operate from a stronger management position than those companies that do not.

Often times a company will get itself into problems because it is out of sync with money that is coming in, and the spending of money that is going out, and is typically why the statement of cash flows plays such an important role in the daily operations of a business.

To easily understand how cash flows work in a business, think of it as like an expanded checking account statement.  If you are like me, twice every month there are cash deposits (inflows or sources) in the form of earnings, and throughout the month there are several purchases or expenditures (outflows or uses) of cash.  Simply put, cash comes in to cover the bills, and cash goes out to pay for them. That’s the basics of cash flow in a nutshell.

Another way to interpret a cash flow statement is to visualize your businesses cash activity as like a river.  All rivers begin (have a source) and an end (have a use).   The origins of the water might come from high mountain tops or runoffs from a myriad of streams, but they will collect to form a flowing river.  Similarly, water can be viewed as money flowing into a business in the form of cash.  As the water collects and generates a current in the river, the cash forms the operations of a business.   The water will flow towards a destination and eventually pour out, as will cash flow towards a destination and get paid out. If all bills are paid, it will accumulate. This is called an end use of cash.

To gain even more clarity, the accounting world categorizes three types of allocations for cash on a cash flow statement.  These are commonly known as operating, investing and financing, and like water, each category can experience inflows or outflows of cash. Let’s take a closer look at each of them.

When we discuss operating activities, we are talking about the main category of cash received from customers (inflows) and cash paid to suppliers and employees (outflows).  Whenever a business purchases a piece of equipment or real estate, it is “investing” in itself, and such investments would be viewed as an expenditure or an (outflow) of cash.  Lastly, a company may need to borrow money from a bank in the form of a loan or a line of credit (an inflow) and then pay that money back in monthly installments as (an outflow).   The key here is to view cash like water –  it has a source, it has its uses, and at the end of the day, there will either be water left in a reservoir (cash) or there won’t be, and the river will be dry.

So when we put all of this together, the next time a customer pays you, and in turn your business has to pay all of the bills associated with the product or service associated with your business, just remember the river analogy, and this should help you better understand all of the components of the statement of cash flows.