No, it is not an overdraft notice from the bank. Your statement of cash flows is a business tool used by many smart businesses to determine their flexibility when preparing budgets, making decisions about asset purchases, and to monitor their level of profitability in relation to cash availability.
What is a statement of cash flows, and what purpose does it serve? A statement of cash flows is a summary of all the cash receipts and cash payments of a business, for a specific period of time, such as a month or a year. Now, why would you want to watch this information, or monitor any changes?
The purpose of the statement of cash flows is to provide an entry for the cash balance shown on your balance sheet. But, in essence, the statement of cash flows provides a business with so much more. An examination of the statement of cash flows will show you exactly where your cash surplus or deficit is coming from.
The statement of cash flows is divided into three specific areas: cash flows from operating activities, cash flows from investing activities, and cash flows from financing activities. Let’s take a quick look at each, hopefully you will then be able to differentiate which area your will tell you the most about the health of your business, or if just one area can provide that much information.
The area of cash flows from operating activities is the meat and potatoes of the statement of cash flows. This area will show you if your sales, your cash receipts, and inventory and your accounts receivables are experiencing any dramatic changes, if your sales are to a great extent credit sales, and if your inventory is shrinking. A good manager or business owner will watch this area closely for suspicious changes, or abrupt changes.
The area of cash flows from investing activities will provide you with a quick reference for any changes in permanent assets. Any sales or purchases of equipment, even bonds, will show up here. The monitoring of investment activities, when used with your operating activities, will tell you when moments of opportunity and need are presenting themselves.
The area of cash flows from financing activities refers to any activity of investing, borrowing, cash withdrawals by the owners, and changes in stock levels.
The statement of cash flows is meant to serve as a bridge between the minute detail of the profit and loss sheet, and the sketchy details of the balance sheet. When properly used, the statement of cash flows will fill in many gaps left in the reporting of information from one level of detail to the next.
What other wonderful piece of information can be gleaned from the statement of cash flows? Your ability to review last month’s or last year’s cash balances against current totals for cash on hand. If you business has been operated efficiently, and the correct investment and purchasing decisions were made, you will see an increase in cash balances, from one time period to the next.