The cash flow statement

Your business needs to have cash on hand to pay salaries, pay your debts, reinvest in your growth, in short, to keep running. You need to ensure that there is always enough cash to cover your obligations.

The fundamental financial statements for businesses to know their financial situation and make management decisions are: the balance sheet, the income statement and the cash flow statement. The latter is the one that will allow you to know how much money the business has in a given period of time, from the follow-up of the transactions that are carried out.

It is also useful to make projections and determine if you have enough liquidity to cover your monthly expenses throughout the year.

What is cash flow?

It is the financial statement that collects all cash inflows and outflows in order to follow the cash movement of the business in a given period and make projections about its behavior in the future. The cash flow complements the economic information in the balance sheet and income statement to provide an overall view of the company's financial situation.

Cash flow is tracked through three activities:

• Operating cash flow: includes all inflows and outflows that derive from the company's business and operating activities. For example purchase and sale of inventory, accounts payable, salary payments and others that do not pertain to investments or financing.
• Cash flow from investments: the cash inflow or outflow through investing activities. For example, cash invested in the purchase and sale of property, equipment and other assets for the purpose of developing the business, or in the acquisition of products from which a future profit is expected.
• Financing cash flow: is the cash inflow and outflow as a result of financial investments derived from its activity. For example, debt collected or payments for services, loans, credit payments. It is the cash used in business financing.

The sum of these three sections gives us the net cash flow.

Importance of the cash flow statement

Careful management of cash flow allows us to:

• Determine the cash available to complete the transactions that need to be made.

• Help measure the ability of the business to finance its operating expenses and meet its obligations.

• Secure a loan or line of credit, since you have to submit this financial report to apply.

• Make viable long-term plans and create strategies to increase profits from projected cash flow.

• Ensure the solvency of the business. A crisis in this sense forces the company to manage a short-term loan to try to balance the situation. Failure to improve can lead to bankruptcy.

• Review changes in the economic value of assets, liabilities and equity.

Why do you need to know your cash flow?

It is the way to know what your net cash flow is, the actual amount of money you have at any given time.

The income statement allows us to see expenses and income in an orderly and detailed way but not necessarily the cash we can dispose of. Your accounting method may show income that you can't use. But by tracking cash, the income statement records are adjusted to show real money by focusing on cash accounting.

Sometimes the situation is not visible to the naked eye; a company may be generating profits, but may not know how to manage the cash flow in its different sections. This financial statement is valuable information for those who know how to interpret these numbers.

How is cash flow determined?

The income statement collects the turnover from sales. Cash flow includes a few more numbers, as it shows the actual amount available for all your resources and all the money paid by the business whether it be taxes, back pay or salary payments, supplies; as well as payments on behalf of the company such as loans and investments.

A simple way to look at this is from the cash on hand (in the bank). To that cash, at the beginning of the month you add the receipts and subtract the disbursement. The following month we would start with that result by adding all the cash contributions (sales, a loan obtained, etc) and subtract all the cash that has gone out for any concept. This would be followed month by month.

There are two methods of calculating cash flow from income statement information, direct and indirect. Both with their formulas. Whichever one you choose will give you a result that you will compare to the net income of the business. The final figure can be positive or negative. Keeping this information on a month-to-month basis helps us predict future cash flow and identify patterns.

The next step is to analyze that information to make the right decisions, either to grow or to change course and avoid financial disaster.

Interpreting cash flow

The information must be analyzed to correctly assess the situation, determine where the problems are and find possible solutions.

Positive result: this is the scenario we want, we can invest in developing the company and meet our obligations. We are always happy to have that positive figure at the end of the report but although it means you have liquidity, it may be due for example to a loan you have obtained and you should l