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Importance of the Cash Flow Statement to a business

Cash Flow Statement

Cash flow statement One of the most important financial statements for a business is the Cash Flow Statement. However, the cash flow statement is often overlooked by many small businesses, as they concentrate on the income statement and the balance sheet.  The cash flow statement provides insight to the cash position of the business, that the balance sheet and income statement do not provide. Generation of sufficient cash is key to a healthy business. The cash flow of a business is important to the long-term success of a business.

The cash flow statement shows the business’s cash inflow and outflow. It breaks down the cash movements in a business into three distinct categories:

  1. Operating Activities
  2. Investing Activities
  3. Financing Activities

Cash Flow Statement

 Information from the cash flow statement is essential for management to make informed decisions for the business. Creditors and Investors also require cash flow statement of a business before they deal with it.

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1) Cash Flow statement shows how much money the business has

A cash flow statement shows if a business is running out of money. A business can be profitable, but it can fail to have money to meet its financial obligations. This is possible because most of the money of the business may be tied up in accounts receivables, while at the same time the business has a huge debt with the bank which needs to be serviced. Failure for the business to meet its financial obligations will lead to a cash crunch or even bankruptcy of the business.

2) Cash Flow Statement shows uses of cash in a business

Cash flow statement shows how you spend money in your business. To be successful in business, you need to understand and manage how you are spending cash.  An income statement does not show the principal loan repayments to a bank. You can have good profits, however, the amount of money you will be paying to the bank may be significant to lead to a cash crisis.  You can plan better if you know how much cash is required every month to make monthly loan repayments.

Purchasing of more inventory and purchasing of fixed assets require cash, but the income statement doesn’t show those figures. It’s important for a business to invest in fixed assets, as that increases the capacity of a business, and will lead to the growth of a business. Cash flow statement also shows how much the owners of the business are paying themselves i.e. dividends. This information is important as it is essential to reinvest some of the profits to the business, for the future growth of the business. It is not wise to bleed the business of cash due to a payment of excessive dividends.

3) Cash flow Statement shows the sources of cash in a business

It’s important for a business to know where most of its cash is coming from. Cash flow statement shows the efficiency of the business in generating cash from its internal operations. For a business to be sustainable in the long run, it should be able to generate a lot of money from its internal operations. A business must not always depend on external sources of cash for its cash requirements. It also shows how much money the business is getting from issuing new loans, disposal of fixed assets, and issuing of new equity capital.

4) Cash Flow Statement helps with the Financing Decision for a business

Growth is essential to the long-term success of a business. Growing a business requires cash. Cash is required for purchasing fixed assets, purchasing more inventory, and growing the capacity of the business. Understanding the cash flow of your business will help determine how you will finance the growth of your small business. You may finance business growth by excess cash from the profits. Borrowing money from the bank can also be used to finance business growth. You may need to raise outside capital. Thus, understanding the cash flow of your business will help you make the financing decision.

About the author

Salman Qureshi

Salman Qureshi is an Accountant by profession & he loves to write on Commerce & Management Sciences Subject to assist Students. Hope you guys will like his effort.

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