why do we prepare cash flow statement
Without cash your business wonвt run, your employees become cranky and suppliers stop shipping you, and believe it or not you can run out of cash while your business is very profitable. That happened to me. When I was in my vending business I had great profits but no cash. I went to a seminar where a couple of very wise people showed me the error of my ways. I learned that profit and loss statements are not nearly as important as cash flow statements when running a small company. A cash flow statement tells you where the money went. A profit and loss statement says nothing about principal payments you make to the bank. You could have reasonably good profits, but the amount of money you pay your bank every month could be putting you out of business. Cash flow statements tell you where you spent your money. If you increased inventory you used cash. If you extended more credit to customers you used cash. If you bought lots of capital equipment you used cash. All three of these issues wonвt show up on your profit and loss statement. A cash flow statement can help you focus on creating excess cash. Having profits is important. Profits are one of the things that help create cash.
There are other things that can also help you create cash. If you can pay less for capital equipment you need you are creating cash while spending money. If you can collect receivables from your customers faster you are creating cash. If you use inventory more efficiently you create cash. Concentrating only on your profit and loss statement makes it difficult to focus on cash. Cash flow statements often provide better KPIвs (Key Performance Indicators) than profit and loss statements. I believe developing excess cash is a great KPI. This is an activity that literally every area of your company can get involved in through individual drivers. I think being able to know what moves the needle on developing excess cash often helps to create value. Knowing what needs to move the needle on profits is only part of the story. Companies that concentrate on creating excess cash often also create better enterprise value than those companies that only concentrate on profits. Cash flow statements help with financing decisions. Buying capital equipment uses cash. Growing capacity in your company uses cash.
Adding inventory uses cash. Adding customers uses cash. The question when we grow our company isnвt whether we will use cash (we will) itвs how are we going to finance our growth. Sometimes youвll just use excess cash provided from profits. Sometimes youвll have to borrow money from the bank. Sometimes youвll need to raise outside capital. Understanding where your cash goes and how you will provide more cash when you need it are key parts of running a successful company. Donвt be like me and run out of cash without knowing why. Understanding your cash flow statement will allow you to make better decisions about your business.
In financial accounting, a cash flow statement, also known as statement of cash flows, is a financial statement that shows how changes in balance sheet accounts and income affect cash and cash equivalents, and breaks the analysis down to operating, investing and financing activities. The cash flow statement is one of the main (5) financial statements. The other four financial statements are: Balance sheet, Income Statement, Statement of Comprehensive Income and Statement of changes in Stockholdersв equity.
In business, there are several reasons for preparing cash flow statement. Some of the major ones are discussed in this article. Cash flow statement helps in efficient management of cash. One of the most important functions of a financial management is to manage cash resources in a manner that sufficient cash is available to meet its short term obligations. Thus, a cash flow statement is a useful tool for doing so. It not only helps managers to ensure that adequate cash is available to meet the liabilities, but it also enables the management to properly plan and coordinate its financial operations. Cash flow from operating activities is a section of the cash flow statement that provides information regarding the cash-generating abilities of a company's core activities. Operating cash flow (or cash flow from operations - CFO) is found in the cash flow statementвs operating activities section. As the repayment of long term debts depends on the availability of cash, the cash flow analysis helps the management in determining the possibility of repayment of long term debts. It thus better predicts the amounts, timing and uncertainty of future cash flows.
As much it is important for finance managers to determine the increase or decrease in cash position, as it is to find the reasons thereof. The cash flow statement aids finance managers greatly in understanding and explaining how the company is short of cash despite the fact that it generates higher profits. Making comparative financial statements is of great value and importance for a business entity for a number of reasons. It helps in assessing the performance over multiple periods. It also reveals information for more than one accounting period. The budgeted cash flow statement, when compared with the actual one, discloses the success or failure of the management in managing cash resources. Not just this, it also aids greatly in taking remedial measures in case there are deviations. It is thus to be said that the cash flow statement is a better tool of analysis. It not only provides information regarding inflows and outflows of cash of a firm for a period of one year, but it also helps finance managers to ensure whether or not sufficient cash is being generated to maintain a healthy business.
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