01/26/2018
Cash Flow Statement-What is it, what does it tell me?
The Cash flow statement is probably the least understood of the financial statements. The reason for this is that financial statement users often forget that GAAP uses accrual accounting. What is accrual accounting? Accrual accounting follows the accounting principle that says that expenses that are incurred must be recorded. So for example, let's say it's 31 January and you just received your telephone bill for January. You are not planning on paying it until 15 February but for the month of January you did have telephone service and therefore incurred that expense, so it must be recognized in the month that it was incurred which is January. Whether by general journal entry or via the Accounts Payable module when we record this bill it will always be a debit to Telephone expense. So when we look at our Income Statement for January we see Telephone expense but it was not necessarily paid in January.
So the Income Statement's Net Income is not a representation of our cash position. It's merely a theoretical look, if you will, at what our cash position would be IF all our revenues were collected and all our expenses were paid in that month. Of course we have other expenses like depreciation that I will write about in another post that is not a cash expense either.
Here we see that we need another statement to show us our cash position and that is what the Cash Flow Statement does. Depending on the method you use, we begin with the Net Income from the Income Statement and then add back non-cash expenses. The most obvious being depreciation; but then you also have that telephone bill we spoke about. It was not paid until February, so we must add it back to the Net Income along with other accruals.
The total net of this exercise gives us Net Cash Flow From Operations; but we are not finished. Next is Investing, which does not mean what you think it means. When we buy furniture or equipment or vehicles for our company, these items are not expensed immediately, they are Capitalized. This means we record them as an asset which shows up on the Balance Sheet. It's never reflected on the Income Statement? Kind of, it is reflected partially in depreciation but I will address that in another post. The bottom line is for such an expense item this must be reflected some how and it is, here in the Investment section of the Cash Flow Statement. We reduce the cash by the amount we paid cash for the item or items and we have a Net Cash Flow From Investments (which is usually a decrease in cash).
Then we have our final section, the Financing Section. This is where we get cash from non-revenue sources. Revenue theoretically is reflected in the Net Income because its in the Income Statement but what if we received a loan? Or if we received funds from the sale of stocks? Or from investors or owners? Certainly that is not revenue but it is cash and we must somehow see it. This is the section we see that cash in. It also may be the area we see pay backs of loans which may result in a cash decrease. So the total net of this section gives us Cash Flow From Financing Activities.
The net-net of these three sections gives us either our Net Increase in Cash or our Net Decrease in Cash.
If you have any questions about Cash Flow Statements or want a free consultation for your business, call us at 646-283-8111.
