The Importance of a Statement of Cash Flows for Future Business Decisions
In every aspect of business it is vital to know the liquidity of a company's assets or the amount of cash they have on hand
. Similarly, it is important to know how your company is spending and receiving their money. The statement of cash flows allows you to see a company's inflows and outflows of cash from their operating, investing, and financing activities. Once the data is displayed, a forecast can be made for future business decisions, which is why a statement of cash flows is an important financial statement for companies.When preparing a statement of cash flows you must first determine whether you are going to use the direct or indirect method of reporting for operating activities. The direct method lists every transaction throughout the period. The direct method also allows a more detailed look into a business' transactions. When using the indirect method the transactions are added together then more simply labeled as net cash provided or used by operating activities. It is important to know that no matter what method, direct or indirect, is used for reporting, the ending cash balance will be the same amount.
The statement of cash flows is broken into three sections: operating, investing, and financing activities. Separating these activities allows for a closer look into a business' actions. Operating activities are compiled of all the transactions that establish net income. More easily stated, an operating transaction or activity is what is made or paid from running a business. An example of an operating activity would be cash paid for employee wages or the collection of cash from customers from sales or services. An investing activity is usually associated with the purchase or sale of long-term assets or the collection and loaning of money as notes receivables. Any financial transaction that affects a long-term liability or owner's equity is listed as a financing activity. An example of a financing activity would be cash paid for dividends or the cash received by issuing stock. Once all of a company's transactions are divided into these sections they are added up and labeled as net increase in cash. That number is then added to the previous cash balance from the last financial period and then labeled as the cash balance at current period-end.
During the process of preparing a statement of cash flows a person may encounter a noncash investing or financing transaction. These types of activities are disclosed in either a note to the statement or at the bottom of the statement itself. These transactions are recorded because of the full-disclosure principle implemented by the FASB. Noncash transactions need to be accounted for because it's important to have knowledge in changes of noncash assets and liabilities.
After the statement of cash flows is completed and analyzed, a planning procedure commonly known as forecasting can be performed. Forecasting is a process executed by management that sets goals and limits for what a company plans on doing the next business period. This process is imperative for good business. Forecasting for operational activities allows a company to set a budget for future business decisions based off history spending depicted on the statement of cash flows, furthermore, accurately allocating funds for spending leaves room for future investing possibilities. The statement of cash flows illustrates investing activities and allows a view to what investments yields the most revenue and gives insight to what investments are the most beneficial for a company. The statement of cash flows also shows financing activities and allows a business to view inflows of cash from the selling of stock, or the outflows of cash from paying dividends. Forecasting is never a hundred percent accurate but performing data analysis on previous business periods presents solid evidence to what may happen.
In conclusion, a statement of cash flows provides an accurate view into what a company's spending and incomes trends are. This data also allows a detailed view to a business' tendencies and gives insight to what their operating, investing, and financing activities are. This information can be gathered, analyzed, and used to produce a forecast for a company's future business periods. Forecasting is essential for companies because it provides an educated estimate to how the company will spend and receive money from their various business activities. Although predictions will never be completely accurate, a proper forecast leaves less room for error when planning a company's future.
The Importance of a Statement of Cash Flows for Future Business Decisions
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