No matter what business or industry you’re in, you would have encountered a cash flow statement at some point. It’s one of the most important things for your business and it’s used for a variety of purposes.

So what is a cash flow statement? Here’s an introduction to the basics.

Let’s get started!

What is a Cash Flow Statement?

A cash flow statement tells you exactly that: how the cash flows in your company. Note that this is based on a period of time (like the Income Statement) and not at a specific point of time (like the Balance Sheet) For example, for the quarter ended, year ended or some other interval. This is one of the financial statements that are produced on an ongoing basis.

Major Categories of a Cash Flow Statement

There are 3 major categories on a cash flow statement: Operating, Investing and Financing

Operating – the flow of cash from your business operations
Investing – the flow of cash from investing activities
Financing – the flow of cash from financing activities

Lava flowing on the ground — Lava flowing just like how cash flows

Accounting Equations

Here is a quick lesson on a formula that you need to know and no, I’m not referring to the Accounting Equation:

Ending Cash Balance = Beginning Cash Balance + Cash Flow from Operations + Cash Flow from Investing Activities + Cash Flow from Financing Activities

There are two different formats of the cash flow statement but it honestly doesn’t matter which one so we won’t go into that in this blog post. If you would like a blog on this topic, please let me know down in the comments. Most of the time, your accountant will determine which method is best for whoever will be reviewing the cash flow statement.

Cash from Operating Activities

As mentioned above, cash from operating activities is the flow of cash from your business operations. There’s a bunch of things that can be categorized as operating activities so we won’t list out a laundry list of examples but we will focus on 3 sample industries.

Keep in mind that anything in the normal course of operations will be classified here. For example, if you own a real estate development company, and you decide to sell off a vehicle, it’s not in the normal course of operations but on the other hand, if you own a car dealership and sell a vehicle, it is.

There are a bunch of examples that are common to every company but here we go with some specific examples for 3 sample industries:

#1 – Construction Company

#2 – Property Landlord

Rent (Basic, TMI, coin-operated washer/dryer) received/receivable
Property tax paid/payable

#3 – Law Firms

Receiving funds in a Trust account
Funds payable to Law Society of Ontario

Most of the time, you don’t need to determine what is considered an operating activity because your accountant will determine that for you. Many accounting software packages also have this capability.

Cash from Investing Activities

As mentioned above, cash flow from investing is the flow of cash from investing activities. This could mean investments that can help support your daily operations or the sale of investments.

Let’s use the same 3 companies above for some examples:

#1 – Construction Company

Purchase of a vehicle for your new project manager or site supervisor
Purchase of mobile equipment to support your excavation operations
Purchase and installation of a new construction management software

#2 – Property Landlord

Replacing an aging roof on a property
Purchase or sale of a new property
Getting an appraisal done on an existing property

#3 – Law Firms

Purchase and installation of a new cloud server
Replacing your computer equipment
Upgrading your office space to create a kitchenette

Cash from Financing Activities

As mentioned above, cash from financing is the flow of cash from financing activities. This includes anything that can help finance your company’s operations. Just think about what you would do if you didn’t have enough cash. That would be considered a financing activity.

Let’s use the same 3 companies above for some examples:

#1 – Construction Company

Revolving line of credit to help with subcontractor payments
Capital lease for the purchase of a tower crane
Issuing dividends to the owners

#2 – Property Landlord

Getting a mortgage on a property (bank, VTB, etc)
Principal repayments on the mortgage
Equity injection from partners

#3 – Law Firm

Loans to/from shareholders
Working capital loan

Shining light bulb on a post-it on a tack board

The Importance of a Cash Flow Statement

Now that we went through some examples of the different categories of a cash flow statement, how is this important for you?

Just to recap, the cash flow statement summarizes the flow of cash within your company over a period of time.

The cash flow statement can be used to:

Determine your working capital needs (some questions that are asked can be ‘are you generating enough cash from your operations?’, ‘how risky is your company?’ or ‘can you sustain operations into the future’)
Identify how cash is being generated or used (some questions that are asked can be ‘do you know how where you are spending your cash?’, ‘do you have excessive financing?’, or ‘are you investing enough into PPE?’)
Supplement cash flow planning (now that you understand how cash is being utilized, are there any changes that you need to make to improve your cash position?)
Reconcile against your Balance Sheet and Income Statement to ensure that the cash balance on the Balance Sheet is the same as the ending cash balance on the Cash Flow Statement

Limitations of a Cash Flow Statement

Not every company will have a cash flow statement as most of the time, it’s based on stakeholder needs. Even if not required, it is a good practice to have a cash flow statement so you can understand how cash is being generated or utilized and whether or not you need to make changes. That being said, there are inherent limitations with this statement.

First, having a cash flow statement that shows you the flow of cash between two periods doesn’t really tell you much, except that how cash was generated or utilized in those periods. It is way more useful to compare this against other periods so you can identify any trends. If your cash flow from operating activities is let’s say $5,000 this month, this only tells you exactly that but nothing else. On the other hand, if you lost $8,000 in cash from operating activities in the next month, you know something is wrong.

Second, what if you have a negative ending cash balance? That doesn’t necessarily mean you’re in trouble because it’s possible that you may have decided to expand your operations. Yes, your cash position might be lower now but your future cash flow would be expected to be better too (that’s why you are expanding your operations).

Third, the cash flow statement is based on a historical basis, that means that it has already happened. By the time this statement is prepared, probably a month have passed so you won’t see any changes that you made right away. This statement is usually a starting point to create or update a cash flow forecast which will provide more insight to your cash position for the future. You can change what could happen in the future, but not for things that have already happened.

Your Turn

Do you have a better understanding of what a cash flow statement is, the different categories, why it’s important and some limitations?

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At JTL CPA, we are Ontario’s virtual accounting firm. Our goal is to automate your accounting and bookkeeping processes in a way that increases financial visibility. Pair that with our value-added approach and tailored advisory solutions gives you the ability to make sound decisions from good data. Check out our website here: https://www.jtlaccounting.com.

Thank you for making it to the end of the blog post. If there are topics that you would like to learn more about in the future, please let us know down in the comments.

The Importance of a Cash Flow Statement

The Importance of Financial Statements

The Importance of an Income Statement