Understanding cashflow is a fundamental part of your financial management. Producing a cashflow statement is one way to drill down into the detail of your finances to get a better handle on your cash position and how it may impact on your future plans.
The statement of cashflows provides key information about your gross payments and receipts, and this allows you to better understand your future income needs. And it does this by breaking your cashflow down into three core areas – operating, investing and financial cashflows.
Let’s look at why you break a cashflow forecast down into these different sections, and what each area tells you about your business health, cash liquidity and your future cashflow.
Cash flow from operating activities
Your cashflow statement gives you a clear overview of where money came into, or out, of the business and how this cash was then used within the company.
It’s important to separate out the underlying health of the business by getting a deep understanding of your operating cashflows and weighing these against the financing decisions behind them. The operating, investment and financing cashflows are fundamentally different parts to your business health, so they need to be broken out and reviewed in their own right – if you don’t, you can miss the overall cash picture.
When analysing your cash process in this way, the starting point will be the operating activities section of the statement.
The operations section of your cashflow statement tells you about the cash you’ve created as a business through your usual day-to-day operations. It also allows you to forecast your future operational cashflows, by looking forwards, rather than simply relying on historical data.
Your operating activities are either:
Cash inflows – the income you’ve generated through selling your products/services, or other revenue streams.
Cash outflows – the direct costs you’ve incurred as company in order to make a produce or deliver a service, or to keep the business trading.
Cash inflows relating to your operating activities may include customers paying your invoices, cash receipts or receipts of interest paid against your bank balance. Cash outflows will cover operating activities such as paying your income tax to the tax authorities, settling a supplier’s bill or paying your staff their wages through your regular payroll run.
By reviewing the operating activities part of your statement, you can quickly and easily start understanding whether your business is generating cash, or if it’s in need of a cash injection – both in the present, or further down the line.
Cash flow from investing activities
Next on the statement comes the investing activities section. This will list any investments where the business is generating revenues from non-current assets (in plain terms, assets that won’t be turned to cash within the current accounting year), or securities that can’t be classed in the balance sheet at cash equivalents.
Your cash inflows from investing activities could include sales in areas such as plant and manufacturing equipment, business property or loan-repayments made to money loaned by the business to directors etc. Cash outflows will cover transactions such as the buying of stocks, or lending money to directors/employees in the business etc.
Being able to drill down into your investment activities gives you better control of your investing decisions. Are you investing the profit made from any operating activity in the right ways, and is it bringing in the required cash inflows to help you fund and grow your expansion plans?
Cash flow from financing activities
The next section of your cashflow statement will be financing activities, where you’ll find the numbers relating to borrowing funds, repaying debts, payments of dividends to your directors and capital that’s been brought into the business during the period in question.
If you’re running a business with major physical assets – such as the manufacturing or high-street retail sectors – it’s important to have a handle on these financing activities and to have the best possible view of your planning across the year.
To put this into a business context, if you take out a loan to buy that essential new piece of production machinery then looking through the financing activities section will allow you to understand how much cash has been expended, or generated, through this transaction.
Over time, as the business grows, having this handle on your cashflow will help you to see if the company is expanding at the desired rate. And being able to provide investors and finance partners with this level of detail into your cash activity has real value – helping them see the potential and growth prospects of the company and how well you’re managing your finances.
Bringing it all together in your bottom line
Lastly, the statement brings together the three preceding sections to give you your net cash flows – or the bottom line for your cashflow statement.
This is where your cash inflows and cash outflows are summed together to show whether the business is in a negative or positive cashflow position. For your company to be financially agile, with the cash needed to cover your operations and trading activity, you should always be aiming for a positive cashflow position.
While this overall positive cashflow position is your key aim, it’s possible that some parts of the statement may be negative, depending on the circumstances of the business. The net position of the company’s cash status may be positive, but it’s possible that you could see negative financing cashflows in some periods; e.g. when repaying a loan. In practice, this negative financing can be offset by an overall positive operating cashflow.
If cash inflows across all three areas of your statement are consistently greater than your cash outflows, you’ll be able to attain positive cashflow. This positive position allows the company to undertake further investment, take on more employees or pay a dividend to directors – all elements that move the business forward.
If your cash outflows are running away with you, then you’ll end up in a negative position – resulting in cashflow shortfalls, unpaid bills to your suppliers and (in the worst case scenario) the failure of the business.
Getting a handle on your cashflow early puts you in the best possible position to respond – and helps you to grasp the opportunities and avoid the possible pitfalls.
Positive cashflow through smart financial management
Having a detailed and up-to date cashflow statement helps your business to monitor inflow and outflow of cash across those three key areas of operations, investments and financing.
By tracking, reviewing and forecasting these numbers regularly, you have the transparent view you need to keep your cash position healthy. With the ability to forecast and model future cashflows across operating, investment and financing activities, you can be much smarter and more proactive about keeping the company in the desired positive cashflow position.