How to Read & Understand a Cash Flow Statement? - AccountingFirms

 A cash flow statement's objective is to present a complete picture of what happened to a company's cash during a set period known as the accounting period. It displays a company's ability to operate in the short and long term based on how much cash flows in and out of the business.

Typically, the cash flow statement is divided into three sections:

• Activities in operation
• Investing actions
• Financing actions

Operating operations describe the cash flow generated after a company delivers its regular goods or services, which includes both revenue and expenses. Investing operations include cash flow from the purchase or sale of assets, such as real estate or vehicles, as well as non-physical property, such as patents, utilising free cash rather than debt. Financing operations describe the cash flow generated by loan and equity financing.

You can use the cash flow statement to understand how much cash different sorts of operations create, and then make company decisions based on your financial statement research.

A company's cash from operational income should ideally frequently surpass its net income, because good cash flow speaks to a company's ability to remain solvent and expand its activities.

Because cash flow differs from profit, a cash flow statement is frequently analysed in conjunction with other financial records such as a balance sheet and income statement.

HOW IS CASH FLOW DETERMINED?

Now that you know what a cash flow statement is and why it's crucial for financial analysis, let's take a look at two popular ways for calculating and preparing the cash flow statement's operating activities section.

Direct Method of Cash Flow Statement

The direct technique, which is based on transactional information that influenced cash throughout the period, is the first way used to calculate the operating section. To compute the operation section directly, add all cash receipts from operating activities and subtract all cash disbursements from operating activities.

Indirect Cash Flow Statement Method

The indirect technique is the second way to compile the operations portion of the statement of cash flows. This approach is based on the accrual accounting system, in which the accountant records revenues and expenses at times other than when cash is paid or received, causing the cash flow from operating activities to deviate from net income.

Rather than organising transactional data as in the direct technique, the accountant begins with the net income figure from the income statement and makes adjustments to offset the impact of accruals made throughout the period.

Essentially, the accountant will convert net income to actual cash flow by de-accruing it from the income statement by identifying any non-cash expenses for the period. Depreciation, or the reduction in the value of an asset over time, and amortisation, or the spreading of payments across numerous periods, are the most prevalent and consistent of these.

HOW TO READ A CASH FLOW STATEMENT

When reviewing any financial statement, analyse it from a business standpoint. Financial documents are intended to offer information about an organization's financial health and condition.

Cash flow figures, for example, might tell whether a company is in its early stages or is a mature and lucrative enterprise. It can also tell whether a company is through a transition or is in decline.

Using this data, an investor may conclude that a company with uneven cash flow is too hazardous to invest in, or that a company with positive cash flow is poised for growth. Similarly, a department head may examine a cash flow statement to determine how their specific department contributes to the company's health and well-being and then utilise that information to change their department's actions. Cash flow may also influence internal actions such as budgeting or hiring (or firing) workers.

Cash flow is often shown as either positive (the company receives more cash than it spends) or negative (the company spends more cash than it receives).

Cash Flow That Is Positive

Positive cash flow means that a corporation has more money flowing into it than out of it over a given time period. This is a good situation since having extra income allows the company to reinvest in itself and its shareholders, pay off debt, and identify new methods to grow the organisation.

However, positive cash flow does not always imply profit. You can be profitable without being cash flow positive, and you can be cash flow positive without earning a profit.

Cash Flow Negative

Negative cash flow indicates that your cash loss exceeds your cash intake within a certain period, but it does not necessarily imply that profit is lost. Instead, a mismatch between expenditure and income may be causing negative cash flow, which should be remedied as soon as feasible.

Negative cash flow can also be created by a firm's decision to expand its operations and invest in future growth, therefore it's critical to examine variations in cash flow from one quarter to the next, as they can reflect how a company is performing overall.

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