What is a cash flow statement and why is it necessary?

A cash flow statement reflects the ability of a company to make money. Making a profit is the objective of all companies. If a company has money, it is alive. Money is like circulating blood – it has to be always on the move; and if it runs out, the end is imminent.

In short, a cash flow statement provides information on the expenditure and revenue of a company. It provides an overview of cash movements from the opening balance to the final balance of a period.

A cash flow statement is an important indicator for the owners of the company; however, it is often considered to be of interest to CFOs only. So, when a company is not big enough to hire a CFO, it often happens that cash movements are left unmonitored and the bookkeeper is frequently asked “But where’s the money? We make profits.”

Why does this happen? The answer is rather obvious: a cash flow statement is in the language that is understandable to CFOs; even bookkeepers often have difficulties in drawing this statement up and cannot explain its contents to the CEO.

But what can be monitored with the help of a cash flow statement and why is this necessary?

A cash flow statement helps to keep an eye on the cash balance of the company.

The cash balance of a company should be one-twelfth of its annual expenses, excluding amortisation. If the cash balance of your company is significantly smaller than one-twelfth of annual expenses, you need to review your expenses. If you reduce the expenses, when necessary, you can increase the balance.

It is similarly bad if the cash balance is significantly higher than that. Either the company has cashed out too much tax-free money or the account holds money that should earn more revenue, not let inflation eat it up.

Cash flows show whether the business is profitable.

A business cash flow statement facilitates analysis of whether the company actually earns money by its business activities. A normal profitable company should use the money earned to buy new fixed assets, pay back loans and pay dividends to the owners of the company.

That is, the statement on the daily use of money shows how much the company earns and spends. This is the most important part of the statement, and it has to be constantly monitored, not just once a year when everything is already in the past.

If the business stays in the positive, it means the company assets that are easily cashed out are growing.

This allows:

• paying back loans;
• reinvest into the business;
• make payments to shareholders;
• cover expenses;
• and build reserves for future financial challenges.

It could easily be that the company is making profits but its clients fail to pay invoices on time and the company still has a shortage of money.

If the company breaks even but a great deal of this is due to amortisation of the initial investments, there is an abundance of money.

The financing cash flow indicates where the incoming money came from.

The financing cash flow recognises:

• information indicating where the additional money came from;
• owners’ contributions/refunds;
• and receipt or payment of a bank loan.

Investment cash flows show where the company has invested the money left over from its daily business activities.

Investment-related cash flows show where the company has invested the money left over from the requisite expenditure. For example, whether the company has acquired more fixed assets, lent out the money or invested it somewhere else.

If the company has, in addition to the above investments, also paid dividends, the company is going strong. But making no further investments and only paying dividends is a worrying sign. This might mean that the company does not grow and develop any longer.

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A cash flow statement gives you the best overview of where the money comes and goes in your company.

A cash flow statement provides you with an overview of cash balance and cash flows from daily business, financing and investments.

Whereas cash flows from financing and investments are mostly reviewed in the annual report when submitting the report, cash flows from daily business activities should be under constant scrutiny, i.e. viewed every day, to notice problems early on and keep your finances under control.

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