Business Plan Financials in Plain English – Cash Flow Statement – Part 15 of the 2009 Business Plan Series

by Steve Fisher on February 27, 2009


The cash flow statement reports the cash generated and used during the time interval specified in its heading. The period of time that the statement covers is chosen by the company. For example, the heading may state “For the Three Months Ended December 31, 2007″ or “The Fiscal Year Ended September 30, 2008″. For many, looking at a cash flow statement it looks a bit weird but it provides a different, yet critically important view of the business.

How is this different than the Income Statement stuff you just talked about in a previous section?

Think of the income statement as a view of revenues booked and expenses accrued. Which means that it is not an accurate picture of how much cash is really on hand. That is where the cash flow statement provides this view of the business.

Investipedia puts it the best:

“The cash flow statement differs from these other financial statements because it acts as a kind of corporate checkbook that reconciles the other two statements. Simply put, the cash flow statement records the company’s cash transactions (the inflows and outflows) during the given period. It shows whether all those lovely revenues booked on the income statement have actually been collected. At the same time, however, remember that the cash flow does not necessarily show all the company’s expenses: not all expenses the company accrues have to be paid right away. So even though the company may have incurred liabilities it must eventually pay, expenses are not recorded as a cash outflow until they are paid (see the section “What Cash Flow Doesn’t Tell Us” below).”

So how can some one have negative net income on their income statement and still be in business?

This is where the cash flow statement comes in. Because the income statement is prepared under the accrual basis of accounting, the revenues reported may not have been collected (translation: you book the business but you haven’t gotten the money yet). Similarly, the expenses reported on the income statement might not have been paid. This is why you leverage the balance sheet which we just covered in part 14. You could review the balance sheet changes to determine the facts, but the cash flow statement already has integrated all that information. As a result, savvy business people and investors utilize this important financial statement.

Four Sections of the Cash Flow Statement
The cash flow statement organizes and reports the cash generated and used in the following categories:

SECTION 1: Operating activities
Converts the items reported on the income statement from the accrual (you book the sale but you might not have the money yet) basis of accounting and includes the following:

  • Cash receipts from sales or for the performance of services
  • Payroll and other payments to employees
  • Payments to suppliers and contractors
  • Rent payments
  • Payments for utilities
  • Tax payments

SECTION 2: Investing activities
Investing activities include capital expenditures – disbursements that are not charged to expense but rather are capitalized as assets on the balance sheet.  Investing activities also include investments (other than cash equivalents as indicated below) that are not part of your normal line of business.  These cash flows could include:

  • Purchases of property, plant and equipment
  • Proceeds from the sale of property, plant and equipment
  • Purchases of stock or other securities (other than cash equivalents)
  • Proceeds from the sale or redemption of investments

SECTION 3: Financing activities
Financing activities include cash flows relating to the business’s debt or equity financing:

  • Proceeds from loans, notes, and other debt instruments
  • Installment payments on loans or other repayment of debts
  • Cash received from the issuance of stock or equity in the business
  • Dividend payments, purchases of treasury stock, or returns of capital

SECTION 4: Supplemental information
Reports the exchange of significant items that did not involve cash and reports the amount of income taxes paid and interest paid.

Two Ways that a Cash Flow Statement is Generated
There are two methods for preparing the cash flow statement – the direct method and the indirect method.  Both methods yield the same result, but different procedures are used to generate the cash flow statement. If you want a great accounting lesson that is not in plain English but extremely good, this site has a page on the Direct Method and the Indirect Method.

Final Thoughts on the Cash Flow Statement

Cash fuels a business, but there are certain things that the cash flow statement doesn’t shed light on. It doesn’t tell the whole profitability story, and the cash flow statement doesn’t do a very good job of indicating the overall financial well-being of the company. It indicates what the company is doing with its cash and where cash is being generated, but it does not account for liabilities and assets, which are recorded on the balance sheet. Furthermore accounts receivable and accounts payable, each of which can be very large for a company, are also not reflected in the cash flow statement.

The bottom line is that the cash flow statement is a compressed version of the company’s checkbook that includes a few other items that affect cash and you should use the income statement and the balance sheet together to provide a clear multi-dimensional view of the business. Hopefully, with these last three sections of the business plan series that the financial section will make more sense to you.

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