Here is the Best Way to Understand Cash Flow Statements for Businesses
Here is the Best Way to Understand Cash Flow Statements for Businesses
In the world of accounting, it's common to delve into cash flow statements. Their function is crucial as they monitor cash inflows and outflows. When you step into the business world, cash flow statements become the primary guide for financial management. Within these statements lie the balance sheet and the profit and loss statement.
From these two statements, you'll determine whether funds are sufficient to open a branch or even to grow more rapidly. Therefore, you need to carefully study cash flow statements.
Below is a comprehensive article on the meaning, function, examples, and how to create cash flow statements. Pay close attention as it will aid you in your business endeavors.
What is a Cash Flow Statement
Broadly speaking, a cash flow statement is a report containing cash expenditures and receipts over a specific period. Often, this report is synchronized with the profit and loss statement. However, they are distinct reports. The cash flow statement states the amount of cash over a specific period. Whereas, the profit and loss statement provide information on how much revenue you can generate from the business.
So, cash flow statements follow what has been established by profit and loss statements. With such a model, you can understand cash flow as a business necessity. Therefore, cash flow statements serve as guidelines for managing finances, enabling you to understand activities ranging from finances to investments.
Functions of Cash Flow Statements
After understanding its definition, you need to know the functions of cash flow statements, or commonly known as cash flow, namely:
- Measure the company's success in generating profits from products.
- Understand the amount of net profit earned.
- Serve as a basis for decision-making to enhance employee productivity.
- Determine cash flow predictions for future periods.
Components of Cash Flow Statements
Cash flow statements consist of three components that you need to be aware of:
- Operating Activities Cash Flow: This component originates from operational business activities. Transactions only involve operational business income and expenses. For example: employee salaries, debt payments, and tax settlements.
- Investment Activities Cash Flow: This section comprises inflows or outflows. This cash flow influences investments in non-current assets. Investment activities are usually related to the sale or purchase of company assets. For example: purchasing fixed assets such as buildings and operational equipment.
- Financing Activities Cash Flow: This component involves transactions that affect the company's capital and equity. Transactions typically involve issuing securities and debts. For example: dividend payments, bond sales, stock issuance, and loan repayments.
Objectives of Cash Flow Statements
After understanding the components of the cash flow statement, the company needs to know the purpose of creating this report. Because from these objectives, the company increasingly understands the importance of cash flow statements.
1. Explaining Liquidity Information
The existence of a cash flow statement actually makes the business more controlled. It can explain information about changes in assets, liabilities, and equity. Also, understanding cash flows in and out. This is important for companies to know. With more transparent, detailed, and comprehensive data, it will be easier to calculate business liquidity in the future.
2. Data Information on Expenditures
From the cash flow statement, companies can find out payments that need to be settled with creditors. Then also understand the amount of cash transactions that have been made, such as purchasing goods for assets and production activities.
3. Maintaining Balanced Cash
Cash flow statements are essential because companies can understand what constitutes expenditures and revenues. If there is excess funds, they can be allocated to other expenditures such as asset purchases. If there is a shortage of funds, companies can find solutions and overcome problems by using other funds.
4. Adjusting for Short-Term Plans
From the cash flow statement, companies can analyze cash outflows and inflows in the previous period, which are then linked to the current period. Because decisions made in the previous period will have an impact on the current period.
Moreover, it is worth noting that successful businesses have sufficient liquid cash to meet short-term plans.
How to Make Cash Flow Statements and Examples
There are two examples in making cash flow statements:
1. Indirect Method
This method is preferred by many because of its simplicity. Simply look at the profit and loss statement to understand cash movements. There is categorization and selection of the most suitable ones for preparing cash flow statements.
2. Direct Method:
When a company uses the direct method, it needs to record cash inflows and outflows in detail because they will be used in the end-of-month reports. In its preparation, three main parts are needed: operational, financing, and investment activities.
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