When reviewing a business’s accounts, its health can be gauged by examining its cash flow. However, before you start this, you need to understand what cash flow is and how it works.
To start, cash flow is the flow of money that happens in a business. To accurately gauge cash flow, you need to look at both the money flowing into the business and the money flowing out. This is typically done over a set time frame, such as a year, a quarter, or a month, rather than for the lifetime of the business.
The aim of any business is to maintain positive cash flow; in other words, there should be more money flowing into the business than out. If the opposite is true, the business is facing negative cash flow, which might be the case for a new business still finding its feet.
Businesses typically monitor their cash flow to support decision-making and day-to-day operations. However, businesses in need of funding might turn to investors who will be very interested in how their cash flow looks and whether they will see a return on their investment, or whether it looks as though the business is heading towards collapse.
A business’s cash flow is typically reported in a cash flow statement. But how do these work?
Understanding a cash flow statement
Typically, a cash flow statement is divided into three main parts: operations, investing and financing. These separate sections allow investors to assess the business’s overall health.
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Cash flow from operations: typically represents revenue and expenses
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Cash flow from investing: how cash flows from buying and selling investments and assets
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Cash flow from financing: includes debt and equity, such as issuing stock, borrowing from lenders, loan repayments, and stock buybacks.
How is a cash flow statement produced?
There are two ways to produce a cash flow statement: direct and indirect. Because the direct method provides a view of the actual cash flows, it is considered more transparent than the indirect method, which uses accrual accounting to produce the statement.
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Direct method: lists the cash receipts and cash payments relating to the operating activities during the period.
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Indirect method: starts with the net income from the income statement and adjusts for non-cash items. You also need to adjust for changes in working capital, including accounts receivable, accounts payable, and inventory.
Why does a cash flow statement matter?
Without understanding cash flow, you won’t have a full understanding of whether a business can cover its regular expenses, such as payroll and utilities. It can also help flag whether the business relies on lending to cover its expenses.
Once you have an in-depth understanding like this, you can begin setting budgets and troubleshooting cash flow problems. Also, from an investor standpoint, you’re able to show how well your business can bring in money and whether you’re covering your expenses.
How can you view a cash flow statement in QuickFile?
Within QuickFile, you can find cash flow statements under Reports >> Other >> Statement of Cash Flows.
Using this report, you can view custom or preset accounting periods and view the cash flow that happens during this period. The report has four headings to give an overview that’s based on both the Direct and Indirect methods.
Alternatively, for a quick overview, there is also the option of a visual flow under Reports >> Income / Expenditure Flows.