Cash Flow is an important METRIC for Business

The cash flow statement is the financial statement that presents the cash inflows and outflows of a business during a given period of time. It is equally as important as the income statement and balance sheet for cash flow analysis. Without a cash flow statement, it may be difficult to have an accurate picture of a company’s performance. The income statement will tell you how much interest you paid on a loan and the balance sheet will tell you how much you owe, but only the cash flow statement will tell you how much cash was consumed servicing that loan. The income statement will record sales and profits but it’s the cash flow statement that will alert you if those sales aren’t generating enough cash to cover expenses.

There are two generally accepted formats for the cash flow statement: the direct method and the indirect method. In both cases, cash flows from three main areas.

Cash flow from operations represents the main type of cash inflow and outflow for a business. Cash comes in from customers and goes out to pay for expenses, including inventory. When thinking about cash inflows from operations, it may be helpful to remember that it is not a measure of revenues. A company could sell $1 million this month and that sale could generate zero in cash if the entire amount is sold on 60-day credit terms. The income statement will show the revenues and the balance sheet will show an increase in accounts receivables, but there won’t be any incoming cash from this activity. Since your business will need to spend cash now to fulfill the order, it’s important to ensure that you have sufficient cash—or access to cash—in order to avoid a cash crunch.

Investment Activities
Cash flow from investment activities represents cash flows mainly from the purchase or sale of fixed assets. It also includes other less common investment-related activities, but its main focus is plant, property and equipment. Cash from these activities is separate from operations because they tend to be for long-term planning and are not directly related to the day-to-day cash operations of a business. A company that consumes large amounts of cash for investment purposes indicates that it is investing for future growth, which consumes cash. If the cash from operations isn’t enough to cover investment activities, then another type of cash flow may be helpful.

Financing Activities
Cash flow from financing activities represents cash flows to and from third-party financial backers. It consists of cash related to debt such as proceeds (cash in) and loan payments (cash out). It also covers cash flow related to equity, such as share purchases (cash in) and dividends (cash out). Cash flow from financing activities helps gauge how much cash the company is generating on a net basis from third parties as opposed to cash from ongoing operations.  



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