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The cash flow statement: definition, methods and benefits

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30 juin 2022
Temps de lecture : 5 min
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When you run a business, cash management can sometimes be difficult. Between suppliers to pay, payment delays and unpaid customers, past or future cash flow can get lost. In order to better manage your cash inflows and outflows, it is essential to use the cash flow statement, an efficient and practical tool. This tool is used both in the strategic management of a company and when raising funds. Cash flow statements greatly facilitate financial monitoring. In this article, you will discover the importance and advantages of cash flow, as well as how to build the chart. It is also necessary to understand the data from this table to better analyze the company's cash flow.

Cash flow statement: Definition.

Like the income statement and the balance sheet, the cash flow statement is an indispensable financial tool in the management of a company. It is one of the three main financial statements of a company. In fact, it makes it possible to present the cash inflows and outflows of any company during a given period. It helps the company to know the profitability of a project, to determine the need for working capital and to foresee its needs for equity capital. The cash flow statement demonstrates whether a company is able to operate over a fairly short period of time and over the long term. It allows the company to forecast and evaluate its financial health.

The need of the cash flow statement in managing your business

The cash flow statement is a tool that offers many advantages for the company. It allows:

  • To evaluate the liquidity and health of a company.
  • To have an accurate understanding of the cash position and cash balance.
  • To measure the amount generated by the operating activity
  • To measure the amount of investments made
  • Assess the need for financing and the financial resources available
  • To warn the company of possible risks of default and insolvency
  • Simplify the development of the financing plan and forecasts.
  • Perform simulations of the impact of management's strategic choices on cash flow
  • To determine the company's strategy and its possible consequences in the future.

  • Structuring and building the cash flow statement

    The cash flow statement includes several elements, namely: the cash flow itself, the cash flow from operations (CAF), the change in WCR (Working Capital Requirement). Before constructing a cash flow statement, it is important to ensure that you have the following documents in your possession: the income statement, which is necessary to determine the cash flow, the cash flow statement to identify the change in WCR (Working Capital Requirement) and finally the balance sheet as well as the accounting annexes.

    Cash flows

    In a cash flow statement, the company's cash inflows and outflows are classified into three categories: operating flows, investing flows and financing flows.

    Operating Cash Flow Activities

    Operating Cash flow activities are the incoming and outgoing flows generated by the company's operating activity that contribute to the determination of the result. That is, the expenses and revenues related to goods and services. The activity flows make it possible to evaluate the capacity of a company to produce cash coming from its activity, while considering the WCR (Working Capital Requirement). It is important to know that the evolution of the activity flows depends on three factors: the evaluation of the operational margins made, the shift of the WCR (Working Capital Requirement) and the growth rate of the sales.

    Investment cash flow activities

    Investment Cash flow activities include all investment and divestment actions taken by the company. They represent the fruits of the company's investment policy on its cash. When we talk about investment operations (inflows), we are talking, for example, about disposals of fixed assets (tangible and intangible), disposals of equity investments or disposals of other financial assets (guarantees, deposits). When we talk about investment operations (outflows), they can be either renewals of equipment or acquisitions of production tools.

    Financing cash flow activities

    Financing Cash Flow activities are generated by the financial decisions (debt/equity) made by the company. We distinguish between incoming and outgoing flows.

    Cash inflows

    Inflows are obtained to meet a temporary cash flow requirement. The main financing inflows are: capital increase, investment grants and borrowing.

    Cash outflows

    Cash outflows are mainly dividend payments or remuneration of shareholders and also the repayment of loans.

    Self-financing capacity (SFC)

    SFC or Self-financing capacity of a company is the total resources generated by its activity to ensure its own financing.

    How to calculate Self-financing capacity (SFC)

    The formula for calculating self-financing capacity is as follows: Self-Financing Capacity = receivable income - payable expenses

    To find the same result, there are two methods of calculation: the first, from the net result, the second, from the Gross Operating Profit GOS

    Self-Financing Capacity calculated using net profit

    The formula is : Self-Financing Capacity = Net Profit - recognised income and proceeds from disposals + recognised expenses and book values of asset disposals Calculated income includes all income that is not cashable. Examples are write-backs of depreciation, write-backs of provisions, or shares of investment grants transferred to the profit and loss account. Conversely, the calculated expenses include all expenses that are not cashable. For example, we have depreciation allowances.

    Self-Financing Capacity calculated using Gross Operating Profit GOS

    The formula is : Self-Financing Capacity = Gross Operating Profit + Cash income - Cash expenses Cash income includes all income to be received or collected that has been excluded from the calculation of Gross Operating Profit. For example, extraordinary income or financial income. Concerning the cash expenses, it is the whole of all the expenses to be disbursed or disbursed which were excluded from the calculation of the Gross Operating Profit. As for example the interests of the current accounts of associates, the fines, the penalties, the bank interests...

    Change in working capital (WCR)

    Presentation and calculation method

    Often referred to as WCR, working capital is a very significant indicator for a company. It represents the time lag between cash outflows and cash inflows related to the company's activity. The calculation formula is as follows: WCR = Current assets - Current liabilities. It is clear that the change in WCR is the difference between two WCRs over two periods (month, quarter, year).

    Interpretation of changes in working capital

    Changes in working capital WCR can be either negative or positive. If the latter is negative, it means that the company was able to invest in short-term assets, or it reduced its short-term assets. On the other hand, if the changes in WCR result in a positive number, it means that the company has increased its current liabilities, or has disposed of current assets. For most developing companies, changes in working capital are associated, in most cases, with investment cycles. The calculation of WCR variations is therefore used to ensure that a company has sufficient liquidity and that it is not on the verge of a cash shortage.

    Free cash flow (FCF)

    Free cash flow is the cash remaining after investments, asset disposals, working capital and subtraction of taxes on operations. Here is the formula for calculating free cash flow: Free cash flow = total operating profit with taxes - total investment in operational capital

    Cash flow: How to calculate it.

    In order to calculate cash flows, he presents two methods. The first method, called direct, is based on the transactions that generated cash inflows and outflows during the period. Then, all the cash inflows related to the operating activity are added and all the expenses, always related to the activity, are subtracted. The second method is the indirect method. The calculation is based on the net result (from the income statement) from which all non-cash expenses such as depreciation, amortization, etc. are removed.

    Significance of cash flow

    Cash flow can be either positive or negative.

    Positive cash flow

    A positive cash flow means that a company generates more incoming funds than outgoing funds over a defined period. Thanks to this surplus of cash, the company has the possibility to use this surplus by reinvesting, by paying dividends to its associates or to settle its debts (we are talking here about loan repayments, payment of supplier debts, etc.)

    Negative cash flow

    A negative cash flow is the result of more cash going out than coming in over a defined period. Negative cash flow does not necessarily indicate that the company is making a loss in the medium or long term. A negative cash flow is often the consequence of strategic decisions for the development of the operating activity.