Lending institutions often request for copies of audited financial statements when you apply for a term loan or invoice financing in India. One of the most important financial statements for a business is the cash flow statement. It provides detailed insights into just how well a business generates and manages its cash.
It is widely used by lenders and investors to gauge the financial position and health of a business. Continue reading to find out all about this specific financial statement, its major components, its limitations and a few cash flow examples.
What is a Cash Flow Statement?
The cash flow statement provides a detailed outline of the various cash inflows and cash outflows of a business during a specific period. The period in question can be monthly, quarterly or annually depending on the size and nature of the business.
In addition to providing a summary of all of the money flow transactions irrespective of their nature, the statement also lets you know whether the business has a positive money flow or a negative money flow. A positive cash/money flow means that there are more cash inflows than outflows, whereas a negative cash/Money flow means that there are more cash outflows than inflows.
What are the 3 Types of Money Flows?
A typical money flow statement format categorises transactions into three types based on their nature. These three types include operating activities, investing activities and financing activities. Here’s a quick overview of each of them.
1. Operating Activities
This section of the money flow statement consists of money flows, both inflows and outflows, arising from the day-to-day operations of the business. Revenue from the sale of products and services, payments to suppliers and employee salaries are some money flow examples you can find in this section. Capital flows from operating activities indicate the health of the core business of a firm. A firm may have a healthy revenue overall, however money flow from operating activities define how well the company is doing in its core activity, and whether the money flow one is seeing on the financial statement is due the firm’s ability to generate money or is it because of the secondary factors.
2. Investing Activities
This section contains fund flow transactions arising from the investment activities of a business. Purchasing and selling property, investing in securities like stocks or bonds and lending money to other businesses are a few fund flow examples you can find listed in this section. Money flow from investing activities highlight the efficiency of a company’s treasury management or cash management activities. It is essentially the money inflow or outflow arising due to the company’s policies around investment and cash management.
3. Financing Activities
This section of the statement consists of fund flows arising from the financing activities that a business carries out. Startup business loans, dividend payments to shareholders, equity share buyback and issue of bonds are some money flow examples you can find in this section. Revenues or money flow from financing activities is one of the most important heads in the financial statement. This highlights the businesses cash generation and payment from activities like debt, etc. This highlights how efficiently the company is using debt financing for its operations, and how easily the company is able to do so. If the company has high money flow from financing activities that means that the company is highly leveraged, and they may not focus on growth opportunities in the short term.
Why do you Need Money Flow Statements?
There are several reasons why money flow statements are considered to be a crucial part of the financial statements of a business. Let’s quickly look at a few reasons why it is deemed to be so.
- The statements provide insights into how liquid a business is and whether it has enough cash on hand to meet its short-term obligations. The statements provide insights into how liquid a business is and whether it has enough cash on hand to meet its short-term obligations. Not only this the statements allow the business to make decisions based on the liquidity position, which enables for better planning and executions on the operations end.
- The statements help investors and lenders assess the financial health and stability of a business. The financial health and stability helps the investors determine if the business is fit for investing or not. If yes, then what does the growth trajectory would look like in the future with the help of the projections based on the current money flow of the company
- The statements can help the management identify potential problems with fund flows in the future, giving them the information they need to formulate strategies to address the issues proactively. If the money flow from the operations is slower than usual, then it indicates difficulty in realizing bills. This can help identify the root cause and take corrective measures
- The statements provide detailed information regarding changes in the liabilities, assets and equity over a certain period. For a layman which may not have insights to the business strategy and long term plan, financial statements can help identify where exactly is the company heading
How is the Money Flow Statement Used?
The Fund flow statement is primarily used by investors, creditors and management to evaluate a business’s ability to generate cash through its operating, investing and financing activities.
The various stakeholders of a business routinely compare the money flow statements of different periods to identify trends, patterns and areas of overspending. The insights such a comparison provides can help stakeholders make informed decisions concerning the business by shining a light on its solvency and liquidity position.
Additionally, the statement is also widely used during the valuation of a business using the Discounted Cash Flow (DCF) method.
How fund Flow is Calculated and its Format?
As you’ve already seen, a typical liquidity flow statement template features three major sections – liquidity flow from operating activities, money flow from investing activities and money flow from financing activities. In addition to these three sections, you will also find the net money flow of the business for the period in question.
Here’s a breakdown of how the money flow for each of the three sections is calculated and the net fund flow is determined.
1. Money Flow from Operating Activities
The following money flow formula is used to calculate money flow from operating activities.
Funds Flow from Operations = (Net income + Non-Cash Expenses – Increase in Current Assets – Decrease in Current Liabilities + Decrease in Current Assets + Increase in Current Liabilities)
Here, net income refers to the revenue remaining after deducting all possible expenses including interest payments, depreciation and taxes. Non-cash expenses, meanwhile, refer to depreciation and amortisation.
Increases in current assets and decreases in current liabilities signify outflows of cash and are hence subtracted from the net income. Decreases in current assets and increases in current liabilities signify inflows of cash and are therefore added to the net income.
2. Money Flow from Investing Activities
To calculate the money flow from investing activities, all you need to do is use the following money flow formula.
Money Flow from Investing Activities =
(Sale of Assets + Redemption of Existing Investments + Dividends and Interest Receipts – Purchase of Assets – New Investments – Loans Provided to Others)
The sale of assets, redemption of investments and dividend and interest payments lead to cash inflows into the business. On the contrary, any new purchases or investments made lead to cash outflows. Even loans that a business provides to other businesses or individuals are considered investment activities.
3. Money Flow from Financing Activities
The following money flow formula is used to calculate money flows from financing activities
Money Flow from Financing Activities = (Proceeds from Stock and Debt issues + Loans Obtained – Stock Repurchase – Repayment of Debt – Payment of Dividends and Interest)
Obtaining business loans and the issue of stocks and bonds lead to cash inflows into the business, whereas repayment of debt, stock buybacks, payment of dividends and interest on loans lead to cash outflows.
4. Net Funds Flow
The net funds flow for the specified period is calculated using the following funds flow formula.
Net Cash Flow = (Cash Flow From Operating Activities + Cash Flow from Investing Activities + Cash Flow from Financing Activities + Cash Balance at the Beginning of the Period)
Now that you’ve seen how to calculate the various sections, let’s take a look at a typical money flow statement format of a business.
| Cash Flow Statement of ABC Limited for the Year Ended March 31, 2023 | ||
| Particulars | Year Ended March 31, 2023 | Year Ended March 31, 2022 |
| A. Money Flows from Operating Activities – Net income – Non-Cash Expenses – Decrease in Current Assets – Increase in Current Liabilities – Increase in Current Assets – Decrease in Current Liabilities | 2,854 326 852 477 (261) (186) | 2,443 482 663 125 (334) (211) |
| 4,062 | 3,168 | |
| B. Money Flows from Operating Activities – Sale of Assets – Redemption of Existing Investments – Dividends and Interest Receipts – Purchase of Assets – New Investments – Loans Provided to Others | 1,088 329 110 (114) (209) (58) | 1,422 227 97 (253) (107) (32) |
| 1,146 | 1,354 | |
| C. Money Flows from Financing Activities – Proceeds from Stock and Debt issues – Loans Obtained – Stock Repurchase – Repayment of Debt – Payment of Dividends and Interest | 353 178 (221) (247) (99) | 221 65 (107) (97) (152) |
| (36) | (70) | |
| D. Net Cash Flow (A + B + C) – Money Flow from Operating Activities – Money Flow from Investing Activities – Money Flow from Financing Activities – Cash Balance at the Beginning of the Year | 4,062 1,146 (36) 81 | 3,168 1,354 (70) 74 |
| 5,253 | 4,526 | |
Limitations of the Cash Flow Statement
Despite the many use cases and benefits, a money flow statement has its share of limitations. Knowing what they are is crucial for making informed decisions. Here’s a brief look at some of the key shortcomings of this financial statement.
- When read on a standalone basis, the statement may not reflect the true state of the finances of a business. For example, a negative money flow may not always be a sign of financial instability or mismanagement. It could simply be due to the business’s efforts to expand aggressively, which may have good results in the future.
- The statement may not accurately capture future money flow uncertainties arising due to adverse market conditions or unforeseen expenditures.
- The statement may not properly account for the timing of money flows, especially if transactions are recognised on an accrual basis.
Also Read: Understanding Essential Business Loan Terms
How to Prepare a Money Flow Statement?
Preparing a fund flow statement requires careful planning and consideration of all cash and non-cash expenses and revenues. Here’s a brief outline of the step-by-step process you need to follow to compile the statement.
- Step 1: Collate all the cash inflows and outflows from operating, investing and financing activities. Ensure that you’re not missing out on any inflow or outflow as it may end up with your financials being inflated or deflated depending upon the error
- Step 2: Categorise each cash inflow and outflow transaction into its appropriate section. It is essential to assign each inflow and outflow to accurate categories, as failing to do so may result in inflated or deflated cashflow in those particular categories which may show a different financial picture than the reality
- Step 3: Calculate the fund flow for each category separately to determine whether there has been a net increase or decrease. You may use a fund flow calculator to make the calculation process easier. If the calculator comes out to be negative that means the business spent more money than received, which may be normal in certain scenarios, and may not be a cause of concern depending upon the business’ position
- Step 4: Combine all the money flows from the three categories and add the cash balance at the beginning of the period in question to the resulting figure to get the net money flow for the period in question. As highlighted earlier, if the net money flow comes out to be negative, then it may not be a cause of concern as this occurrence can happen, however it also means that the net revenue is negative and the business actually burned cash instead of making profit
- Step 5: Present all of the information in the appropriate fund flow statement template applicable to your business. Relevance, verifiability, faithful representation, comparability, timeliness, and understandability are the six qualitative characteristics of a financial statement. The business should ensure that these qualities are implemented in the statements
Difference Between Fund Flow Statements and Other Financial Statements
The fund flow statement makes up only one-third of the financial statements of a business; the other two being the profit and loss account and balance sheet respectively. Comparing these financial statements with each other, it becomes clear that there are plenty of differences setting each of them apart.
inflows and outflows of a business for a specific period. The profit and loss account, meanwhile, gives you a report of the various sources of revenue and expenses of the business. The balance sheet, on the other hand, only provides a snapshot of the various assets owned and liabilities owed by the business.
Conclusion
The fund flow statement is an important financial statement that’s crucial for assessing the financial health and stability of a business. However, analysing the statement on a standalone basis may not always provide a comprehensive overview of its financial situation.
A better option would be to examine the fund flow statement along with the balance sheet and the profit and loss statement. This allows you to get a more comprehensive outlook on the finances of the business and enables you to make informed financial decisions.
Frequently Asked Questions
1. What is the cash flow formula with an example?
The cash flow formula refers to the mathematical formula businesses use to calculate cash flow from operations. Here’s a quick look at the formula used to calculate it.
Cash Flow from Operations = Net income + Non-Cash Expenses – Increase in Current Assets – Decrease in Current Liabilities + Decrease in Current Assets + Increase in Current Liabilities
Now, assume a business has a net income of ₹25 lakhs, depreciation expenses amounting to ₹2 lakhs, an increase in inventory worth ₹3 lakhs and an increase in deferred revenue from customers to the tune of ₹1.5 lakhs. If you substitute these values in the above-mentioned cash flow formula, you will get the operating cash flow for the business.
Cash Flow from Operations = ₹25.5 lakhs (₹25 lakhs + ₹2 lakhs – ₹3 lakhs + 1.5 lakhs)
2. What is an example of a cash flow in a business?
A business purchasing raw material or inventory from its supplier is an example of a cash flow. Here, the cash flows out of the business since the entity pays money to its supplier in exchange for receiving goods.
3.What is the basic cash flow statement?
A basic cash flow statement features inflows and outflows under three major categories – cash flow from operations, cash flow from investing and cash flow from financing.
4. What is the monthly cash flow statement?
A monthly cash flow statement is a detailed record of all the inflows and outflows in a business across three major categories – cash flow from operations, cash flow from investing and cash flow from financing – for a particular month.
5. Is cash flow a profit?
No. Cash flows are not profits for a business. They merely represent the amount of cash that flows into and out of a business during a specific period. Profits, meanwhile, represent the revenue left over after deducting all possible cash and non-cash expenses like interest payments, depreciation and taxes.
