Cash flow budget (short form)
Cash flow budget (long form)
A cash flow statement is one of the most important financial statements for a project or business. The statement can be as simple as a one page analysis or may involve several schedules that feed information into a central statement.
A cash flow statement is a listing of the flows of cash into and out of the business or project. Think of it as your checking account at the bank. Deposits are the cash inflow and withdrawals (checks) are the cash outflows. The balance in your checking account is your net cash flow at a specific point in time.
A cash flow statement is a listing of cash flows that occurred during the past accounting period. A projection of future flows of cash is called a cash flow budget. You can think of a cash flow budget as a projection of the future deposits and withdrawals to your checking account.
A cash flow statement is not only concerned with the amount of the cash flows but also the timing of the flows. Many cash flows are constructed with multiple time periods. For example, it may list monthly cash inflows and outflows over a year’s time. It not only projects the cash balance remaining at the end of the year but also the cash balance for each month.
Working capital is an important part of a cash flow analysis. It is defined as the amount of money needed to facilitate business operations and transactions, and is calculated as current assets (cash or near cash assets) less current liabilities (liabilities due during the upcoming accounting period). Computing the amount of working capital gives you a quick analysis of the liquidity of the business over the future accounting period. If working capital appears to be sufficient, developing a cash flow budget may not be critical. But if working capital appears to be insufficient, a cash flow budget may highlight liquidity problems that may occur during the coming year.
Most statements are constructed so that you can identify each individual inflow or outflow item with a place for a description of the item. Statements like Decision Tool Cash Flow Budget (12 periods) provides a flexible tool for simple cash flow projections. A more comprehensive tool for a Farm Cash Flow (Decision Tool) is also available. A more in-depth discussion of creating a cash flow budget is Twelve Steps to Cash Flow Budgeting.
Some cash flow budgets are constructed so that you can monitor the accuracy of your projections. These budgets allow you to make monthly cash flow projections for the coming year and also enter actual inflows and outflows as you progress through the year. This will allow you to compare your projections to your actual cash flows and make adjustments to the projections for the remainder of the year.
Reasons for Creating a Cash Flow Budget
Think of cash as the ingredient that makes the business operate smoothly just as grease is the ingredient that makes a machine function smoothly. Without adequate cash a business cannot function because many of the transactions require cash to complete them.
By creating a cash flow budget you can project sources and applications of funds for the upcoming time periods. You will identify any cash deficit periods in advance so you can take corrective actions now to alleviate the deficit. This may involve shifting the timing of certain transactions. It may also determine when money will be borrowed. If borrowing is involved, it will also determine the amount of cash that needs to be borrowed.
Periods of excess cash can also be identified. This information can be used to direct excess cash into interest bearing assets where additional revenue can be generated or to scheduled loan payments.
Cash Flow is not Profitability
People often mistakenly believe that a cash flow statement will show the profitability of a business or project. Although closely related, cash flow and profitability are different. A cash flow statement lists cash inflows and cash outflows while the income statement lists income and expenses. A cash flow statement shows liquidity while an income statement shows profitability.
Many income items are also cash inflows. The sales of crops and livestock are usually both income and cash inflows. The timing is also usually the same as long as a check is received and deposited in your account at the time of the sale. Many expense items are also cash outflow items. The purchase of livestock feed (cash method of accounting) is both an expense and a cash outflow item. The timing is also the same if a check is written at the time of purchase.
However, there are many cash items that are not income and expense items, and vice versa. For example, the purchase of a tractor is a cash outflow if you pay cash at the time of purchase as shown in the example in Table 1. If money is borrowed for the purchase using a term loan, the down payment is a cash outflow at the time of purchase and the annual principal and interest payments are cash outflows each year as shown in Table 2.
The tractor is a capital asset and has a life of more than one year. It is included as an expense item in an income statement by the amount it declines in value due to wear and obsolescence. This is called “depreciation”. The cost of depreciation is listed every year. In the tables below a $70,000 tractor is depreciated over seven years at the rate of $10,000 per year.
Depreciation calculated for income tax purposes can be used. However, to more accurately calculate net income, a realistic depreciation amount should be used to approximate the actual decline in the value of the machine during the year.
In Table 2, where the purchase is financed, the amount of interest paid on the loan is included as an expense, along with depreciation, because interest is the cost of borrowing money. However, principal payments are not an expense but merely a cash transfer between you and your lender.
Other Financial Statements
A cash flow statement is only one of several financial statements that can be used to measure the financial strength of a business. Other common statements include the balance sheet or Net Worth Statement and the Income Statement, although there are several other statements that may be included.
These statements fit together to form a comprehensive financial picture of the business. The balance sheet or net worth statement shows the solvency of the business at a specific point in time. Statements are often prepared at the beginning and ending of the accounting period (i.e. January 1). The statement records the assets of the business and their value and the liabilities or financial claims against the business, i.e. debts. The amount by which assets exceed liabilities is the “net worth” of the business. The net worth reflects the current value of investment in the business by the owners.
The income statement is a dynamic statement that records income and expenses over the accounting period. The net income (loss) for the period increases (decreases) the net worth of the business (as shown in the ending balance sheet versus the beginning balance sheet).
A Complete set of Financial Statements (Decision Tool), including the beginning and ending net worth statements, the income statement, the cash flow statement, the statement of owner equity and the financial performance measures is available to do a comprehensive financial analysis of your business.
To help you assess the financial health of your business, Financial Performance Measures allows you to give your business a check-up and helps you to understand what these performance measures mean for your business.
Reviewed by Kelvin Leibold, extension field specialist,
Don Hofstrand, retired extension value added agriculture specialist,
One question is fundamental to any business: How much money is coming in versus how much is going out? A cash flow statement answers that and provides a clear picture of whether a company has the cash it needs to pay its debts and fund operating expenses over a set timeframe. It’s one of the most important sources of insight into a company’s financial health.
What Is a Cash Flow Statement (CFS)?
A cash flow statement, also known as a statement of cash flows, is a financial statement that documents the cash and cash equivalents a company generates and spends over a specific period. Cash flow statements reveal a business’s liquidity, help evaluate changes in assets, liabilities and equity, and make it easier when analysing operating performance.
Key takeaways
- Cash flow statements show the cash impact of the decisions a company makes on operating, investing and financing activities.
- A cash flow statement consists of three sections: cash from operating activities, cash from investing activities and cash from financing activities.
- There are two methods for cash flow statement preparation: direct and indirect.
- The direct method determines changes in cash receipts and payments. The indirect method takes the net income generated in a period and adds or subtracts changes in the asset and liability accounts to determine the implied cash flow.
- A key component for any company are the changes in accounts receivable.
- Investing activities should include asset purchases and sales, interest paid on loans, and payments related to mergers and acquisitions.
- Negative cash flow is not always a cause for alarm; some businesses choose to spend more to meet business goals and may rely on financing to get them to positive cash flow generation.
Why Do Businesses Need Cash Flow Statements?
The cash flow statement serves as a bridge between the income statement and the balance sheet. There are four key reasons why a cash flow statement is important:
- It reveals a business’ liquidity so that companies know just how much cash is on hand, and thus their projected runway to when cash is projected to run out.
- It details the specific changes in assets, liabilities and equity.
- It eliminates the effects of different bookkeeping techniques (for example cash basis versus accrual basis accounting), making it easier for investors to compare multiple firms’ financial performance.
- It helps analyse and forecast the amount, timing and probability of future cash needs.
How Cash Flow Statements Work
All publicly traded companies must file financial reports and statements with the Securities and Exchange Commission (SEC). The cash flow statement is one of three critical documents, along with the balance sheet and income statement, included in SEC filings. It provides information about cash receipts, cash payments and the net change in cash resulting from a company’s operating, investing and financing activities.
Investors look to the cash flow statement for insights into a company’s financial footing. Meanwhile, creditors can use the cash flow statement to gauge liquidity and determine whether a company can fund its operating expenses and pay off its debts.
What Is Included in a Cash Flow Statement?
A cash flow statement consists of three key components:
- Cash flow from operating activities involves any cash flows from current assets and current liabilities. This section includes transactions from all operational business activities, including buying and selling inventory and supplies as well as paying employee salaries.
- Cash flow from investing activities reflects results from investment gains and losses. This section includes transactions such as equipment purchases, loans made to suppliers or mergers and acquisitions. Analysts can rely on this section to find changes in capital expenditures (CapEx).
- Cash flow from financing activities measures cash flow between a company and its owners and creditors. This section involves cash transactions related to raising money from stock or debt or repaying that debt. When cash flow from financing activities contains a positive number, it’s a sign that there is more cash inflow than outflow. When the number is negative, it may indicate that a company is paying off debt, making dividend payments or buying back stock.
Additionally, the cash flow statement may include disclosure of non-cash activities when prepared under generally accepted accounting principles (GAAP)—items like fixed asset depreciation, goodwill amortisation and the like.
How is a Cash Flow Statement Produced?
There are two methods of cash flow statement preparation: direct and indirect. The best choice for your business depends on how much detail you need to include in your statement, as well as how much time you are willing to dedicate. While both methods are GAAP-approved, the International Accounting Standards Board (IASB) prefers the direct reporting method. However, most small businesses use the indirect method.
Direct vs. Indirect Methods of Producing a Cash Flow Statement
The main difference between the direct method and the indirect method of presenting the statement of cash flows (SCF) involves the cash flows from operating activities. There are no differences in the cash flows from investing activities and the cash flows from financing activities under either method—the real difference lies in the operating activities.
- Direct cash flow method: This method relies on cash-basis accounting. Finance records revenues and expenses as cash is received or disbursed by the business. The direct method requires more organisation and legwork, since you subtract actual cash flows from inflows. Common line items using this method include customer receipts, payments to suppliers and employees, interest and dividends received and income tax payments.
- Indirect cash flow method: This method is based on accrual-basis accounting, meaning revenue and expenses are counted when they are incurred rather than when money actually changes hands. Finance looks at the transactions recorded on the income statement and selectively reverses some of them to eliminate transactions that don’t show the movement of cash. This method also requires adjustments to add back any non-operating activities, such as depreciation, that don’t impact operating cash flow.
Accounts Receivable and Cash Flow
When it comes to the balance sheet, any changes in accounts receivable must be reflected in cash flow. A decrease in accounts receivable implies that more cash has entered the company from customers paying off credit accounts. The amount accounts receivable decreased is added to the company’s net sales. However, if accounts receivable increases, the amount of the increase must be deducted from net sales. That’s because, while accounts receivable amounts count as revenue, they are not cash.
Inventory Value and Cash Flow
When inventory increases, it indicates that a company has spent money on raw materials. If cash were used in the purchase of that inventory, the increase would be deducted from net sales. On the flip side, if there were a decrease in inventory, that would be added to net sales. If the inventory was purchased on credit instead of cash, the balance sheet would reflect an increase in accounts payable, and that year-over-year increase would be added to net sales.
Investing Activities and Cash Flow
Investing activities account for the income of a company’s investments. More specifically, these activities may include an asset purchase or sale, interest from loans or payments related to mergers and acquisitions.
Cash changes from making investments are considered use items, because cash is used on expenditures such as property, equipment or short-term assets. But when an asset is divested, that transaction is considered a source and is listed in cash from investing activities.
Cash From Financing Activities
Financing activities involve both cash inflows and outflows from creditors. This category comprises the money that comes from investors or banks, dividend payments, and goes out for stock repurchases and the repayment of loans.
Not all financing activities involve the use of cash, and only activities that impact cash are reported in the cash flow statement. Non-cash financing activities include the conversion of debt to common stock or issuing a bond payable to discharge the liability.
A business’ financing activities shed light on its overall financial health and goals. For example, positive cash flow from financing activities is indicative of growth and expansion. More money flowing into a business signifies an increase in business assets. Meanwhile, cash outflows from financing activities can signify improved liquidity. It may mean that a company has paid off long-term debt or made a dividend payment to shareholders.
Negative Cash Flow Statements
In general, a positive cash flow statement is a sign of a healthy company. And yet a negative cash flow statement is not in itself cause for alarm. It may mean a business is new and has spent a lot of money on property or equipment. Or, it could mean the business is in growth mode.
For example, Netflix had a negative cash flow for years while the company increased spending on original content. It was a gamble, but some investors saw the strategy as a positive. More original content meant the business would be better equipped to compete with other streaming services and TV networks.
Balance Sheet and Income Statement
The cash flow statement serves as a bridge between the income statement and the balance sheet by showing how cash moves in and out of a business during a specific period. The balance sheet involves a company’s assets and liabilities from one period to the next while the income statement covers expenses and income over time.
Finance can reference both the balance sheet and the income statement while preparing a cash flow statement. The net cash flow in the cash flow statement between periods should equal the change in cash between consecutive balance sheets of the period that the cash flow statement covers. The cash flow statement is formulated by subtracting non-cash items from the income statement.
Cash Flow Statement Example
Below is an example of a cash flow statement for Macy’s department stores.