Why use a Statement of Cash Flows?
The Statement of Cash Flows is a financial statement typically presented alongside the Profit & Loss and Balance Sheet to show the sources and uses of cash for a given company.
It provides information about cash generated from general operations alongside cash raised or used for financing and investing activities. Fathom uses the indirect method to calculate the movement of cash in the period from operating, investing and financing activities.
Well known statistics suggest that over 50% of small businesses have negative cash flow. Often the most important factor for driving long term success is a businesses ability to manage its expenditure. Fathom’s statement of cash flows and cash flow waterfall can provide vital information to help business owners drive effective decisions to manage their cashflow.
Key considerations when managing cash flows:
Seasonality of the business - when does the business see its busiest periods, and on what terms are our invoices paid by customers.
Cash outflows - when do we typically pay our suppliers, debtors and employees.
Debt - can we cover our short and long term liabilities, alternatively, do we need financing to keep up with general business expenses.
What is the Indirect Method?
The indirect method for calculating cash flows starts with net income for a given period and adjusts it for ‘non-cash expenses’ as well as changes in balance sheet accounts that affect cash.
This differs from the direct method, which takes into account the cash receipts and payments made during a given period for a business.
Common non-cash expenses:
Depreciation & Amortisation expenses
Unrealised Gains & Losses
Accounts Receivable write-offs, etc.
The standard rule of thumb is to subtract the increase of asset accounts from net income, and add the decrease of asset accounts to net income. The opposite rule applies to liabilities here.
Asset account increases, subtract this from net income
Asset account decreases, add this back to net income
Liability account increases, add this back to net income
Liability account decreases, subtract this from net income
The key is to think about each account and how its movements (increases or decreases) affect the overall cash position of the company. The classification of an account determines how it will be treated when calculating cash flow.
Example A: Depreciation is a non-cash expense. As such, the indirect method adds the Depreciation expense amount to net income.
Example B: An increase in accounts receivable is a use of cash and a subtraction from net income as the company is providing a product or service ‘on credit’.
Within Fathom you are able to view your cash flow results in two layouts; operating / investing / financing or operating / free cash flow / net cash flow.
The operating / investing / financing layout is often used when reconciling monthly management reports to statutory reporting tools. Alternatively, the Operating cash flow / Free cash flow / Net cash flow layout, may give you more insight into overall financial performance, and more transparency in how your cash has been used.
Sources and uses of cash from the normal course of business.
Sources and uses of cash resulting from amounts spent on investments in capital assets, such as plant and equipment.
Sources and uses of cash from long-term liabilities, including the issuance of stock or redemption of bonds.
Free Cash Flow
Measure of the cash generated after accounting for capital expenditures, like buildings or machinery.
Net Cash Flow
Measure of difference between the company’s overall cash inflows and outflows for a given period. Shows you the ‘net’ movement in cash within the company.
Additional knowledge & common questions: