This article introduces the main parts of a typical Cash Flow Statement. Essentially, all Cash Flow Statements around the world record the same essential predictions grouped into five basic sections.
However, the layout of actual Cash Flow Statements in different countries can vary slightly. So, we need to be prepared that the main classifications of Cash Inflows and Cash Outflows might be in a different order.
The elements of Cash Flow Statement
Cash Flow Statement is the record of all the cash received by a business and all the cash outflows from the business over a period of time. It is important to follow and record those movements of cash as all business activity results in a flow of cash either into the business or out of the business.
Section 1 – Opening Balance
Opening Balance shows the cash balance at the start of the month; specifically, on the first day of the month.
Section 2 – Cash Inflows
Cash Inflows record all the cash payments into the business that happen in the certain month. Here, the cash is flowing to the business. Predicting Cash Inflows requires very accurate Sales Forecasting.
Here are examples of typical Cash Inflows. Some of these following inflows will be much easier to forecast than others.
- Cash from sales. Most of the Cash Inflows usually come from customers’ cash purchases. It is from Sales Revenue when customers pay for the products (goods and services) that they have bought.
- Debtors. These include late payments from debtors – accounts receivable payments. Or, in other words, payments from those customers who have bought products on credit. Usually, one month’s credit is agreed and granted, but sometimes trade credit of two months or even three months is given.
- Overdrafts. The overdraft may provide necessary cash on demand, but the amount received will be rather small.
- Bank loans. These will be easy to forecast as they have been agreed with the bank in advance in terms of the amount of money lent to the company and the exact timing of transfers.
- Interest. These are interests earned from savings deposits when the business keeps its cash in the bank.
- Sale of Fixed Assets. Cash from the sale of old Fixed Assets might be a one-time random inflow. The amount of money earned from selling Fixed Assets will usually be very significant.
- Owners’ cash injections. Capital injections from the current owners and potential investors can be an important source of finance especially during the times of crisis. This will be completely under the owners’ direct control as it is them who add their own cash into the business.
Section 3 – Cash Outflows
Cash Outflows record all the cash payments made by the business that happen in the certain month. Here, the cash is leaving the business. Predicting Cash Outflows requires very accurate Budgeting.
Here are examples of typical Cash Outflows. Some of these outflows will be much easier to budget than others.
- Raw materials. The cost of these would vary consistently with demand for products, so forecasting sales levels could be used to assess the spending on necessary materials.
- Wages. Labor cost payments include wages paid to production workers per hour or per piece produced. These payments could vary from month to month depending on demand fluctuations and types of employee contracts.
- Lease payments. Lease payments for equipment are easy to forecast with equal monthly payments over the period of one year.
- Rent. Rental payments for premises are easy to forecast as the property is usually rented for longer period of time with equal monthly or quarterly payments. The amount of rent will be agreed with the landlord and fixed for a specific period of time.
- Salaries. These payments to managers are agreed on annual basis and paid monthly, so quite easy to budget for.
- Advertising. Spending on promotion will depend on the intensity, frequency and scope. Companies using above-the-line promotion will need to budget to spend much more than companies using cheaper below-the-line promotion.
- Utilities. Bills for electricity, gas, water, telephone and the Internet are very difficult to forecast. These payments will vary depending on the number of customers, the weather conditions, energy prices, etc.
- Office supplies. This will include variable cost payments such as printing paper, stationery, cleaning materials, etc.
- Interest payments on loans. Repayments on bank loans and overdrafts will be fairly predictable and constant every month, but will vary depending on the level of interest rates in the country.
- TAXes. These payments to the government usually happen only once a year.
- Dividends. Dividend-paying businesses will record this cash outflow while companies that do not pay dividends will not spend any cash here. Dividends are usually paid quarterly, but some real estate companies also pay monthly.
- Purchase of Fixed Assets. This might be a one-time random spending. The amount of money spent on purchasing Fixed Assets will usually be very significant.
Section 4 – Net Cash Flow
Net Cash Flow shows the difference between monthly Cash Inflows and Cash Outflows. Net Cash Flow is calculated in the following way:
Net Cash Flow = Cash Inflows – Cash Outflows
The Net Cash Flow can be either positive, zero or negative. Positive Net Cash Flow is when Cash Inflows are larger than Cash Outflows. Net Cash Flow is zero when Cash Inflows equal to Cash Outflows. And, negative Net Cash Flow is when Cash Outflows are larger than Cash Inflows.
Ideally, monthly Net Cash Flow should be positive, so the business receives more cash from receipts than it spends on expenses. With large enough Opening Balance, the firm may have negative Net Cash Flow for a while and still keep on operating normally.
However, in the long-term perspective, constant negative Net Cash Flow will lead to cash flow problems. And, as the survival of any business depends on the Cash Inflows being greater than the Cash Outflows, having a positive cash flow will avoid any cash shortage that may cause liquidity problems and result in an increase in borrowing costs.
To prevent a negative Net Cash Flow from happening any time in the future, businesses need as accurate Cash Flow Forecast as possible regarding the amount and timing of all Cash Inflows and Cash Outflows. This will help business managers to identify any future time periods when cash shortages may occur to prevent problems with Working Capital.
Section 5 – Closing Balance
Closing Balance shows how much cash the business expects to have at the end of the month; specifically, on the last day of the month. Cash held at the end of the previous month becomes next month’s Opening Balance. Closing Balance is calculated in the following way:
Closing Balance = Opening Balance + Net Cash Flow
The most important line in any Cash Flow Statement is the one containing the Closing Balance. If Closing Balance is negative, then the business will need to raise short-term finance urgently in order to have enough cash available to cover next month’s Cash Outflows.
If a business knows in advance that there is going to be a period of cash shortage, it can act to try to prevent this from happening. If a business’s cash position is forecasted to become negative despite that, management might decide to finance this with an overdraft. However, overdrafts can be a very expensive source of finance. Before deciding to use an overdraft, management should consider all possible ways of reducing the next month’s Cash Outflows. Even if the managers only reduce the size of the forecasted cash shortage, this will at least reduce the size and cost of the required overdraft.
Constructing Cash Flow Statement
Here is the complete Cash Flow Statement for our famous hamburger restaurant. This Cash Flow Statement shows simplified three-month cash flows. It only shows the cash position of the business without any indication of the profit or loss made.
Opening Balance of USD$5,000 is the amount of cash at the beginning of the trading period starting on January 1. Notice that the Opening Balance of USD$6,000 in February is the same value as the preceding month’s Closing Balance of USD$6,000 on January 31.
It can be observed that while the hamburger restaurant made decent sales between January and March represented by ‘Cash from sales’ and ‘Payments for Debtors’ starting from February, the company has recorded many Cash Outflows. In fact, in the first three months of the year, Total Cash Inflows have been decreasing while Total Cash Outflows have been increasing causing Net Cash Flow to decrease every month. And, to even become negative starting as early as from February. There was only one month – January, the first month of operation – in which the monthly Net Cash Flow was positive.
Notice that the restaurant’s Closing Balance in March is 0. This means that the business has no cash left at the end of March – the business ran out of all its cash in just three months.
In cash terms, the restaurant appears to be in a bad position at the end of the three-month period.
Because no business can survive without sufficient cash, the restaurant’s manager has to devise a plan how to deal with possible future cash shortages. If possible, managers need to increase the cash inflows or reduce the cash outflows.
Alternatively, if the business cannot do that, the restaurant might, for example, seek to take out a bank overdraft as a short-term measure to deal with this liquidity problem. However, this option is costlier than increasing Cash Inflows and Reducing Cash Outflows.
