One way of gauging a business’ cash position is monitoring the money it generates against how much it uses by preparing a Cash Flow Statement.
It’s not always as straightforward as that since recording accounts receivables and accounts payables will throw you a curveball.
Here’s what you would typically find in a Cash Flow Statement, and how account receivables present in the Cash Flow Statement. But first...
Also known as a Statement of Cash Flows, it is one of the main financial statements documenting the total amount of cash and cash equivalents your business received and used during a specified period.
A Cash Flow Statement (CFS) highlights changes in assets, equity, and liability, charting the total change in use of cash during the period. This reveals a business’ liquidity and helps analyze a company’s operating activities.
Besides acting as a bridge between the balance sheet and the income statement, there are at least five reasons why businesses keep CFS:
- You can prove to investors that your company is on a solid financial footing by producing a squeaky-clean CFS. So, how do you prove your business’ liquidity? That’s where CFS’ come in handy as they show the exact position of your company’s cash flow.
- Go into details about the changes in assets, liabilities, and equity in the form of cash balance, cash inflows, and cash outflows. These three form the accounting equation, helping you measure business performance.
- It makes it easier for investors to compare your business’s performance to others. For instance, one firm might be using accrual basis accounting while another uses cash basis; CFS provides a level field that eliminates the effects of these different bookkeeping techniques.
- A CFS can help predict future cash flows as you can create cash flow projections by planning how much liquidity you expect in the future, vital for long-term business plans.
- The only way you can secure a loan or line of credit is by keeping your CFS up-to-date.
When your CFS has a negative number, that usually means you lost money during that accounting period. However, just because you have a negative number does not mean you panic.
A negative balance doesn’t always spell doom and gloom. Sometimes you might decide to spend more cash than usual in the hope of future returns, such as investing in office equipment.
For instance, Netflix racked up negative cash flows for years as it increased spending to come up with compelling content against its competitors, with the gamble paying off handsomely.
Generally, a positive cash flow indicates you have a healthy business. In the long run, it isn’t always a cause for popping champagne. While it may mean the business is currently liquid, a positive cash flow may have been a result of taking out a loan to keep the business afloat.
If you are starting out, you can do the bookkeeping in Excel, with the income statement and balance sheets helping you calculate the CFS.
Once you advance, you could use the information entered in the general ledger to automate the CFS-making process using accounting software.
There are two main methods of generally accepted accounting principles (GAAP) that can help you develop a CFS:
1. Direct method
It refers to cash-basis accounting as you record every transaction whenever you receive or disburse cash, only bringing it up when preparing the CFS at the end of the month.
As you can tell, it takes more effort since you need to track every cash transaction, and then subtract cash flow from the inflow. That includes items such as cash receipts, interest received, and income tax payments.
2. Indirect method
Small businesses prefer this method to track cash received and cash payments from the business. They can record transactions whenever they accrue, rather than when cash changes hands, a method known as accrual accounting.
Incidentally, that means you’d have to go back to the income statement to eliminate transactions that do not reflect cash transfers. It may seem tedious, but the upshot is you don’t have to go back to reconcile your statements.
A CFS is different from the other financial statements as it has three main sections:
- Cash flow from operations: contains data on incoming cash from current assets and current liabilities, including all operational business activities such as salaries, and buying and selling inventory.
- Cash flow from investing activities: shows your investment losses and gains. An analyst can use this to work out the capital expenditure (CapEx) changes. For example, it includes transactions like mergers and acquisitions, or purchasing equipment.
- Cash provided by financing activities: is cash spent or earned through financing with loans, owner’s equity, or lines of credit. Briefly, it reveals the cash flow between you, your business, and its creditors from raising money from debt, stock, or debt amortization. After you’re done with all the calculations, you will be left with the net cash flow.
The CFS may also include non-cash items such as obsolescence and depreciation expenses. Depreciation and amortization reduce net income in the income statement, although you add them back to the CFS as they are non-cash expenses.
It’s tempting to label cash flow as ‘cash in’ or ‘cash out,’ but the way a business uses its cash or receives it is more nuanced than that, necessitating the preparation of accounts receivable and accounts payable.
When a company purchases supplies, it may not necessarily pay straight away. They may get an allowance of 30, 60, 90, or 120 days before the supplier requires payments. The purchaser records this short-term liability as accounts payable on the balance sheet.
For the purchaser, that is akin to a source of cash as it increases cash flow and cash in hand.
Although providing longer payment options can harm your cash flow, what if we told you there is a solution that allows you to do that without harming cash flow?
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Further, you may be hesitant to offer such terms to everyone since a PwC Global Economic Crime and Fraud Survey of 2020 found that companies lost a combined $42 billion to fraud.
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On the other hand, accounts receivables refer to cash due to your business for services or goods delivered but not paid. Put differently, these are the outstanding invoices unpaid by customers.
It is a short-term line of credit extended to regular customers with an obligation to pay within a set date, often 30, 60, 90, or 120 days.
Account receivables are cash to your business and a short-term liability to the customer. Your cash flow considerations will determine how long you can allow a customer to go without paying.
On the balance sheet, the supplier records the short-term credit as current assets, affecting cash flow as accounts payable. Allowing a customer some time before they pay is an account receivable.
For instance, if you make a sale of $10,000 with terms of sale at 50% cash and 50% credit payable within 60 days, record the $5,000 as sales since it is a cash inflow. You will record the balance as an inflow when it is paid.
Here, Resolve can come in handy to enhance your accounts receivable. Did you know that Resolve makes net terms risk-free? We shoulder all the risk as we are the lender.
What’s more, we offer up to 90% of customer’s invoices, processed within one day. After analyzing a client, we advise you to grant them 30, 60, or 90 days within which to pay us. That way, your business will always have cash flow, whatever your accounts receivable situation.
In the double-entry system of bookkeeping, if you make credit sales, debit accounts receivable—meanwhile, credit cash sales as income.
If you use the accrual concept, that means accounts receivable will increase along with sales, that is to say, Net Profit.
The CFS’s starting point is Net Profit, which increases although there are no cash transactions; this is unacceptable. Therefore, deduct any net profit or indirect sales that do not involve such transactions.
You have to deduct increases in accounts receivables from the Net Profit to Cash Used from operations.
Deduct increases in accounts receivables from Net Profit while adding decreases in accounts receivables to Net Profit.
When you debit cash or bank account against accounts receivable, only accounts receivable will affect cash flow. Thus, record this movement in the CFS.
Firstly, subtract the current period cash amount from accounts receivable from the previous period cash amount. A positive difference shows an accounts receivable increase, signifying cash usage and indicating a cash flow decline by the same amount.
Conversely, a negative number indicates a cash flow increase of the same amount.
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