A cash flow statement is a statement that reveals how cash was utilized by an entity. The report explains the free cash flow of an entity and can be used in investment appraisals and forecasting.
1. What's a cash flow statement?
A cash flow statement is a part of an entity's financial or management report that is presented to the shareholders, general public, and management. The report tells what constitutes cash flows into the entity and cash flows out of the company. This is referred to as cash inflow and outflow.
Generally, the outflow is subtracted from the outflow to arrive at the net cash flow. The statement usually includes three categories; cash flows from operations, investing, and financing activities. When the cash flow from financing activities is not included or available in the statement, the net cash flow equals the free cash flow of the entity.Â
As explained in this article, free cash flow is available to top-level management for investing, paying dividends to shareholders, and settling debt decisions. The cash flow statement is a useful report for forecasting and investment appraisals of companies. Financial analysts use them to carry out feasibility studies and make investing decisions.
2. Main categories of the cash flow statement
The main categories of a statement of cash flow are operating, investing, and financing activities. These activities are explained below:
2.1 Operating activitiesÂ
These are cash inflows and outflows from the daily operations of the entity. By operations, we mean what the business is engaged with daily. Therefore, cash flows from these represent operating activities.Â
- The cash inflows and outflows include but are not limited to
- Sales of goods or the rendering of services.
- Purchase of goods or materials relating to the sales or rendering of services.
- Payment for various expenses such as electricity, cleaning, and security. Excluding payment of loan debt.
- Cash sum is paid to supplies to settle their debts, and that is received from customers to clear their debts.
- Taxes paid to the government.
2.2 Investing activities
Investing activities are capital expenditures. That is money spent on acquiring property, plants (PPE), and equipment during the year. Also, the disposal of PPE can be included and represent a cash inflow to the entity. Acquisition of equity and debt instruments from loaner companies and loans to a third party by the entity form part of investing activities.
2.3 Financial activities
This category relates to the shareholders of the entity. When shares are issued to shareholders, the value is a cash-in flow. However, when a dividend is paid out, it is a cash outflow.Â
3. How net cash flow is computed
The net cash flow is the sum of the operating, investing, and financing activities. By sum, we mean both additions and subtractions of the various categories. The cash outflows will be subtracted from the cash inflow of each activity. This will result in net cash flow from operating activities, net cash flow from investing activities, and net cash flows from financing activities.
Next, the activities are summed up together to get the net cash flows. The figure of the net cash flow is added to the cash and cash equivalent balance for the previous period.Â
4. Uses of the cash flow statement
The statement of cash flow is useful in several ways. Below we explain two areas in which the report can be used.
4.1 Cash flow forecasting
A cash flow report can be used to forecast future cash flows to the entity. Using forecasting tools like probability and so on, the expected future cash flow can be determined. This can be used as a basis for decisions in future periods.
4.2 Investment appraisals
Cash flow statements can be used for appraisals of a proposed investment. The entity will factor in the cash inflows and outflows during its feasibility and make the necessary decision. The entity's cash flows can be discounted to their present value during the appraisal to achieve a determinable value of the investment.
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