The ins and outs of a Cash Flow Statement

A cash flow statement is a crucial financial statement that provides a summary of the inflows and outflows of cash within a business. It is typically divided into three key areas, namely Operating Cash Flow, Investing Cash Flow, and Financing Cash Flow.

1. Operating Cash Flow: This section, also known as cash flow from operating activities, reflects the cash flow from day-to-day business operations. It includes payments from customers and payments to suppliers, as well as payments to employees (think of them as a supplier to the business), rents, and other running costs. Operating Cashflow forecasts assist in instilling the discipline of regularly reviewing debtors and collectors positions and following up on delays for early warning signs of customer financial distress or dissatisfaction with service/products provided.
2. Investing Cash Flow: This section, also known as cash flow from investing activities, records payments for fixed assets and long-life assets, such as purchasing premises (not rent), motor vehicles, and other non-current assets. For lease assets, interest and principal should be separated. This section is important as it reflects the capital expenditure decisions made by the business, including investments in plant and equipment, research and development, and other growth initiatives.
3. Financing Cash Flow: This section, also known as cash flow from financing activities, reflects the payments to and from suppliers of capital to the business, including debt drawdowns and repayments, interest, equity investment, share buyback, and dividends. It is important to note that this section shows how the business gets its funding and represents the raising and repayment of debt, the costs of servicing debt via interest payments, and equity payment flows in the form of retained cash earnings, equity raising (increases), and buybacks (reductions).

Each section should net off inflows and outflows to show the generation or application of cash in the key segments. The cash flow statement should reconcile with the business bank account at the end of each month. The P&L via accruals (income statement) and the Balance Sheet carry the differences in timing between costs incurred and cash payments (P&L) as well as the store of asset value (Balance Sheet). Asset usage via depreciation charges then flows through to the P&L.

In conclusion, the cash flow statement is a vital component of a business’s financial reporting as it provides insight into the cash position of the business and helps identify any potential issues that may arise in the future. It is essential to provide a detailed statement that is tailored to the nature of each business, in order to facilitate issue identification.

The Cash Flow Statement enables forecasting of free cash flow that can be distributed to shareholders via dividends and/or capital returns. It also helps owners assess the possibility of leveraging the business to generate free cash for distributions, provided that there is sufficient debt servicing capability. The decision regarding the structure and form of the debt facility will depend on the strength of the operating cash flow. The risk assessment and the decision of the structure of the debt facility most suitable for the business will depend on the duration of asset lives, reliability of contracted cash flow, and level of robustness.