The Cash Flow Statement: How much money flows into and out of the company

2. The Cash Flow Statement: How much money flows in and out.
3. The structure of the Cash Flow Statement
4. Connection of the Cash Flow Statement with the Balance Sheet
5. How do you make a Cash Flow Statement?
6. The liquidity budget
7. Objective of the Cash Flow Statement
8. Costs versus Payment
9. Conclusion

The cash flow statement is one of the three financial statements. Together with the Profit and Loss Statement and the Balance Sheet, it forms the hart of Financial Management. The cash flow statement shows how much money the company has entered and how much the company has left. Because it is an overview of activities, it will always relate to a period just like the Profit and Loss Statement.

What is the importance of the Cash Flow Statement? Companies DO NOT go bankrupt because they make losses! Companies go bankrupt because they cannot pay the bills. In other words, Cash is King!

1. The Three Overviews of Financial Management

All companies report annually in the form of financial statements. Small companies do this especially for the tax authorities, large companies also do this to inform their owners and other interested parties. This "informing" is done by making an annual report that consists of information from the Board of Directors, the Supervisory Board, a statement from the auditor and a Financial Statements. The latter is the numerical part and is again composed out of three overviews. The structure of Financial Management is the same throughout the world and the three overviews are the Profit and Loss Statement, the Balance Sheet and the Cash Flow Statement.

1.1 The Profit and Loss Statement: The overview of performed minus used.Value Cycle Balance Sheet P&L CF

The Profit and Loss Statement is the most discussed financial overview and provides insight into the profitability of the activities of companies: What, and for what value, has been realized on delivered products and services. The costs are deducted from this. This is the value of the items and time consumed to realize the deliveries. Read here my extensive article about the Profit and Loss account.

1.2 The Balance Sheet: What do I have and to whom does it belong?

The Balance is in equivalence because all belongings with their value are described on the right-hand side of the balance sheet. These are the assets of the company that it uses and consumes for carrying out the activities. On the left side of the balance sheet, that we call the equity and liabilities, we describe who has which claim to the company. The balance is in balance because on the one hand it describes "what do I have" and on the other side it describes "to whom does it belong". Read my extensive article about the Balance Sheet here.

2. The Cash Flow Statement: How much money flows in and out.

The Cash Flow Statement shows how much money the company is flowing in and out within the specified period. These flows can be measured objectively on the basis of the bank accounts and cash registers and are therefore very objectively determined. Hence the saying: Profit is an opinion cash is a fact.

3. The structure of the Cash Flow Statement

The Cash Flow Statement consists out of three parts:

3.1 The Operational Cash Flow

The Operational cash flow describes all cash flows that originate with the company's normal activities. You can think of customer receipts and payments to employees, suppliers, rent, government and the like.

Example of Operational Cash Flow

The Operating Cash Flow is, just like the Profit from the Profit and Loss Statement, a good indicator of the performance of the company. The Operational Cash Flow is the source from which the Investments and the payments to the owners and loan capital providers are paid. In other words, the Operational Cash Flow is the source for the Investment Cash Flow and the Finance Cash Flow. That is why it is very important that the Operational Cash Flow shows large inflows so that investments can be made and capital providers can be paid. Large fluctuations can be normal between periods. Think of a Christmas tree seller who has his receipt in one month and 12 months of payments.

3.2 The Investment Cash Flow

The investment cash flow relates to all cash flows that have to do with items that you will use for a longer period of time for your company. Think of land, buildings or machines, all items that you use multiple periods. This also includes, for example, payments for shares in other companies.

Example of Investing Cash Flow

Investments can also be sold over time (divestments) that provide a cash inflow in this category.

3.3 The Financing Cash Flow

The Financing Cash Flow relates to all cash flows to and from the owners of the company and the flows to the providers of debt. With regard to the owners, you can issue or buy back shares and you can choose to pay a dividend. With regard to the providers of loans you can withdraw or repay them and of course interest has to be paid.

Example of Financing Cash FlowExample of Cash Flow Statement

4. Connection of the Cash Flow Statement with the Balance Sheet

The three overviews of Financial Management are linked. After all, all three reflect the activities of one company for a specific period of time. The operating cash flow relates to the parts of the balance sheet that I use once. Think of stocks, but also debtors and creditors. The investment cash flow relates to the parts of the balance sheet that I use multiple times. These are the Fixed Assets such as buildings and machines. The Financing Cash Flow relates to the providers of capital (which receive something for this) such as Equity Providers and loan providers.

The relation between the Cash Flow Statement and the Balance Sheet


5. How do you make a Cash Flow Statement?

To make a cash flow statement, there are two methods

5.1 The Cash Book or the Direct Method

In the direct method you use a Cash Book. Here you describe which inflows and outflows have been happening in a specific period. This method is only applied by small companies.

5.2 The Indirect Method

All large companies apply the Indirect Method. This means that no cash book is kept but that the cash flow is calculated on the basis of the Profit and Loss account and the balance sheet changes. The outcome of this method is then compared with the positions of the cash at the beginning and the end of the period to make sure it is correct.

5.3 How does the Indirect Method work?

The Indirect method starts with the Operating Profit from the Profit and Loss Account. By starting at EBIT, we apply the result prior to payment to equity providers and loan capital providers (read the financing cash flow). Subsequently two groups of corrections are made.

We know from the Profit and Loss Statement that the profit is reduced due to depreciation. These costs relate to investments (investment cash flow) from the past. We must therefore increase the profit with the depreciation.

The second group of corrections relate to the Balance Sheet. After all, if I have more stocks in the warehouse, that means I have less money on the bank. Also if my customers pay me later (higher debtors) or if I pay my suppliers earlier (lower creditors), this will have negative consequences for my bank balance.

6. The liquidity budget

Why do companies create a liquidity budget (= prognosis of the cash flow over the months)? As described in the introduction, companies will only go bankrupt if insufficient cash is available to make necessary payments. If you are going to apply for a job at a company and notice that the liquidity budget is very important, you know that they are either in heavy weather or have an activist shareholder ...... In addition, it is of course very important that if you have to bridge a period of low cash levels you investigate the options at the bank as early as possible so you have time to negotiate and find multiple options.

7. Objective of the Cash Flow Statement

As with all financial statements, the objective of the cash flow statement is to be "in control". In other words, knowing what is going on within the organization and responding to it with actions to realize improvements. The goal of the Profit and Loss Statement is to maximize the profit. For the Cash Flow Statement this need not be the case. We want to use the cash wisely and want to be able to invest and repay our capital providers.

For example, I have a lot of cash inflow because I have a fantastic product that sells very well and my customers pay me very quickly, or I have a large cash inflow because I have sold a piece of land or have taken out a loan. Likewise the other way around. I have a big money outflow because my clients do not pay due to quality issues with my product because I have built a new factory or because I have paid off a mortgage. The type of cash flow determines whether cash inflow or outflow is "good" or “bad”. Operating cash flow nevertheless must be high. The investment cash flow may be negative, after all, I am preparing for the future. The financing cash flow to the shareholder may be large ;-) the flow for interest is preferably low.

8. Costs versus paymentCosts versus Cash

A common mistake among non-financial professionals is that they make no difference between costs and payment. Costs relate to the use or consumption of items. Payments relate to transferring money and represent a cash out. Consumption is shown on the Profit and Loss Statement and has an impact on profitability. Payments are shown on the Cash Flow Statement and have an impact on the cash balance. Conclusion: If you buy a building you have a cash outflow, while you use it you have costs.

9. Conclusion

In this article I described how the cash flow statement is structured and which information I can derive from the overview. It is important to remember that the cash flow ultimately determines whether a company will continue to exist or go bankrupt. Only if there is nobody to find who has faith in the future of the company and the money bag to substantiate his opinion, the company goes bankrupt, Profit or Loss is not important. Within the Corporate Finance discipline, we further develop future cash flows and assess on the basis of time and risk where we invest our money in.

Operating cash flows must be positive because new investments can be made on the basis of this and the capital providers can be paid. The most important thing however from the Cash Flow Statement: No surprises! I need to be in control!

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