Cash Flow Statement: What Is Its Purpose?
Before we discuss the purpose of a cash flow statement, let’s first discuss what it is. The three sections of the cash flow statement are operating, investing and financing. There are two methods to use when preparing your cash flow statement, the direct method and the indirect method.
The cash flow statement is a summary of the transactions that affected cash or cash equivalents (i.e. Accounts Receivable) in a particular period. In other words it is a summary of all the cash payments and the cash receipts that occurred during the month, quarter or year for a business.
Each section of the cash flow statement will give insight into your business activities and where your cash came from or where it went to.
The operating section of the cash flow statement will give you information on the cash generated by your sales and production activities found on the income statement.
The investing section of the cash flow statement will tell you how you are utilizing your cash in your business.
For example if you are purchasing equipment. The financing section will tell you if you are borrowing money or if you are paying down debt. Both the activities for the investing and financing section of the cash flow statement are found on the balance sheet.
This leads us to the purpose of the cash flow statement. The cash flow statement ties together all the details from the income statement and the balance sheet to give you a summary of the overall picture of your cash inflows and outflows for your business.
Seeing your business in this summarized format will help you understand how the detailed transactions affect your business. When reviewing the cash flow statement you should be able to see how the business’ cash increased or decreased for the period.
The cash flow statement also removes any non-cash transactions that may be on the income statement like depreciation expense for equipment. This allows us to look at how and in what areas the business is generating cash, or not generating cash. Armed with this information you will be able to make adjustments to your operations, or investing or financing activities.