What is a cashflow statement? 

The Cash flow statement provides a different, complementary view of the company’s financial performance than what is revealed in the Profit and Loss Statement – it shows precisely how much cash the organisation has generated. This aspect of the accounts may not be clear from the P&L.

Let’s take an example: 

We have a retail store that sells various clothing items. On a particular day, the total revenue generated is Rs.100,000/-. This includes sales from different categories, such as shirts amounting to Rs.40,000/-, pants amounting to Rs.30,000/-, and accessories amounting to Rs.30,000/-. The revenue figures are accurately recorded in the Profit & Loss Account, leaving no room for uncertainty.

Now, let’s imagine a furniture store that specialises in selling sofas. Each sofa is priced at Rs.20,000/-. On a given day, they manage to sell 15 sofas, resulting in a total income of Rs.300,000/-. However, in this scenario, three sofas are sold on credit, meaning the customers take possession of the sofas but defer payment to a later date. This alters the numbers.

Cash sales: 12 * 20000 = Rs.240,000/-

Credit sales: 3 * 20000 = Rs.60,000/-

Total sales: Rs.300,000/-

If we look at the store’s Profit & Loss statement, the total income may be Rs.300,000/-. However, the actual cash available in their bank account could be less than that amount. For instance, the store may have expenses to cover, such as supplier payments or rental fees, which can leave them with a lower cash balance. It’s important to consider these factors to have a clear understanding of the store’s financial position.

Analysing the cash flow statement becomes crucial in assessing the company’s actual cash situation. It provides valuable information about the cash inflows and outflows, helping evaluate the company’s liquidity and financial health. Ultimately, a company’s financial well-being relies not just on the profits earned but also on its cash flow and liquidity position.

– Activities of a company 

To fully understand the cash flow statement, it is crucial to have a clear understanding of a company’s activities. With the multitude of business activities that a company engages in, they can be effectively classified into three common categories. To provide a clearer illustration, let’s examine an example.

One can think of a fitness centre with a solid corporate structure, such as Cult doing various things. These could include offering memberships, providing personal training sessions, and selling sports and fitness equipment. Additionally, they may offer activities ranging from group classes to nutrition counselling.

1. Utilise visual advertisements to entice potential customers
2. Employ fitness instructors to assist clients in their fitness routines
3. Acquire new fitness equipment to replace worn-out machinery
4. Secure a short-term loan from financial institutions
5. Generate funds by issuing a certificate of deposit
6. Issue new shares to select acquaintances for the purpose of raising fresh capital, also known as preferential allotment
7. Invest in a startup company that focuses on innovative fitness programs
8. Allocate surplus funds to fixed deposits
9. Invest in a nearby construction project to establish a future fitness centre
10. Enhance the sound system to enhance the workout experience

One can see that the variety of business activities is substantial. However, they all correlate to the company and can be divided into:

1. Operational activities (OA): referring to any tasks associated with daily business operations. Examples of OA include sales, marketing, production, technology advancement and recruiting personnel.
2. Investing activities (IA): involves putting capital into assets with the expectation of gaining a financial return. This could include parking funds in interest-bearing accounts, investing in equity shares, buying land, property, plant and equipment, intangibles and other non-current assets.
3. Financing activities (FA): The companies’ financing activities involve a range of financial transactions, such as distributing dividends, servicing debt, taking on new debt and issuing corporate bonds.

A legitimate company’s activities can be categorised into three groups.

Considering the three actions mentioned above, let us put them into three distinct categories.

1. Utilise display advertisements to attract prospective customers – (OA)
2. Employ fitness trainers to assist clients in their workout routines -(OA)
3. Purchase new fitness equipment to replace worn-out machinery – (OA)
4. Seek short-term financing from banks – (FA)
5. Generate funds by issuing a certificate of deposit (CD) – (FA)
6. Issue new shares to a select group of acquaintances for capital expansion, also known as preferential allotment – (FA)
7. Invest in a startup company focused on innovative fitness programs – (IA)
8. Deposit excess funds in fixed-term deposits – (IA)
9. Invest in an upcoming building in the vicinity for the potential future establishment of a fitness centre –  (IA)
10. Upgrade the sound system to enhance the workout experience – (OA)

It’s important to consider the effect of cash flow into and out of business on its cash balance; each action taken can have a direct impact. Take, for example, investing in an enhanced sound system for clients during their workouts; this means money must be paid out, thus reducing the balance. However,  the new sound system will become a company asset.

Considering this, let us examine how the activities listed for the example will affect the cash balance and, subsequently, the balance sheet.

The table above is colour coded:

Cash inflows are represented by the colour blue, while cash outflows are indicated by the colour red. Assets are visually distinguished with the colour green. Liabilities are purple. 

Examining the table, it’s clear that there is a link between the Cash Balance and Asset/Liability columns.

Whenever the liabilities of the firm grow, so do its cash reserves. 

This implies a decrease in liabilities results in a lower cash balance.

Whenever the company’s assets rise, its cash reserve dwindles.

When assets decrease, the cash balance increases.

The above point is paramount when constructing a cash flow statement. Moreover, when adequately considered, it becomes evident that every company’s movement leads either to a net influx of cash or a net decrease in available funds, depending on whether their activity is categorised as operating, financing or investing.