As most business owners already know, keeping track of financial transactions is an important part of accounting. While there are several documents used to achieve this goal, today we’re going to focus on cash flow statements.
Cash Flow Statements: The Basics
A cash flow statement, also known as a statement of cash flows, is a type of financial statement that reveals changes in a business’s balance sheet accounts while revealing both incoming and outgoing cash. Like its name implies, the cash flow statement focuses on cash transactions. It doesn’t hold the same level of importance as other financial statements like income statements and balance sheets. Nonetheless, cash flow statements should still be a regular part of business accounting, especially for businesses that perform cash transactions.
Do I Really Need to Maintain Cash Flow Statements
While there’s no rule stating that business owners must create and maintain cash flow statements, doing so offers several key benefits. For starters, cash flow statements help business owners project short-term viability, which of course is helpful for making decisions. If your business is spending more cash than it’s generating, you may want to avoid unnecessary expenses — until your cash flow statement begins trending in the opposite direction.
The 3 ‘Activities’ in a Cash Flow Statement
A typical business’s cash flow statement will include the following three activities:
- Operating Activities: Any activity a business conducts that generates revenue is considered an operating activity. This includes but is not limited to sales, commissions, interest earned on investments, payroll, etc.
- Investing Activities: Any payment that’s made with the goal of acquiring an asset is an investing activity. This includes buying fixed assets and selling securities.
- Financing Activities: Any activity that changes the equity of a business is a financial activity. This includes selling shares of the company, repurchasing shares, or making dividend payments.
Direct vs Indirect
There are also several different ways to prepare a cash flow statement, the most common of which include direct and indirect.
A direct cash flow statement reports major classes of cash receipts and payments. An indirect cash flow statement, on the other hand, uses a net-income metric as the base on which to make adjustments for transactions that do not involve cash. Using this information, it performs adjustments on all cash transactions. Of the two methods, most professional accountants prefer the direct method to make cash flash statements.
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