The purpose of any financial statement is to provide information about an entity’s transaction history that is USEFUL for internal and external users. You can read more about accounting and the purpose of Financial Statements here (refer to What is accounting blog). Financials must also be made using the Accrual Method of Accounting, if prepared for external users. (refer to accrual blog)
Depending on your age, business structure and personal preference, the Statement of Cash Flow is also called the Cash Flow Statement.
CASH FLOW EXPLAINED
This financial statement explains how CASH flowed throughout the entity. This statement explains how and why CASH AND CASH EQUIVALENTS changed. Cash and Cash Equivalents are items that are currently short term, highly liquid investments (assets) and can be converted to Cash in a short period of time, usually 90 days or less.
WHERE IS THE CASH
Since financials are usually prepared using the Accrual Basis of Accounting, revenues and expenses (as well as other items) are recorded WITHOUT the related CASH impact. However, CASH IS KING in any business, so it is crucial that business owners understand WHERE THEIR CASH WENT each period.
3 MAJOR CASH FLOW ACTIVITIES
Cash Flow is broken into three major activities: Operating, Investing and Financing:
Operating Activities =
Producing goods and / or delivering services to customers. Everything NOT included in other activities are by default Operating activities.
Investing Activities =
Cash flow changes as a result from GAINS / LOSSES. In other words, change in cash NOT as a result from CORE BUSINESS.
Financing Activities =
Changes in cash due to EQUITY transactions, such as raising capital, repaying investors, paying cash dividends etc…
WHAT YOU GET
When analyzing this financial statement, you can reconcile Net Income to Cash and explain how and why the Cash Balances change during each period.
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