How To Read Financial Statements - Understanding Cash Flows


By Easwar Koovappadi

Cash flows , both inflows and outflows are the heartbeat of any business. Various groups of people focus on this. Lenders and investors, business managers and last but not the least, investors. More businesses have failed not due to a lack of profitability but due to a lack of cash. Cash is needed for the day to day operations of a business such as purchasing raw materials, paying expenses, paying interest on loans, taxes etc. Stated simply a cash flow statement tracks the movements of funds.

Exhibit 1 below, provides a summary for Great Widgets, Inc , both for operations related and others. Operations related are those that are directly engaged in operations of the business; purchases, manufacture and sales. Financing cash flows are those that are related to financing the business - loans obtained and repaid, capital raised and so on. Funds flows from an investing perspective are investing in the business such as assets purchase and so on. What these do is clearly bring to focus: How much is from operations and how much from others.

Exhibit 1:

Part A:

Cash flows from operations (Profit-making flows that results in Revenue inflows and expense outflows)

From customers for product sales from this year $ 5,400,000

From customers for product sales made to them last year $ 1,200,000

Purchase of raw materials for making products for sale ($ 700,000)

Purchase of services for making products for sale ($ 300,000)

Payments for salaries, wages and other expenses ($ 500,000)

Paid interest on loans, line of credit etc ($ 10,000)

Payment of income tax - due from last year ($ 50,000)

Net cash increase during the year $5,040,000

Part B:

Flows from financing activities

Repaid loans to bank ($1,000,000)

Flows from Financing activities ($1,000,000)

Part C:

From investing activities

Bought Machinery for the business ($ 50,000)

Flows from Investing activities ($ 40,000)

Net increase/decrease in cash flows from all sources $ 4,000,000

The first part of the exhibit describes those arising from various activities such as collections from customers, payment for manufacture of products, payments on account of payroll and expenses. The second part of the exhibit deals with the flows connected with the financing activities, such as taking loans, and repayment of loans. The third part deals with the investment in the business.

In the absence of a statement that illustrates the cash flow, we would not be able to understand how much was generated from operations and others.

Easwar has an extensive knowledge of issues related to currency, exchange, taxes, cost savings ideas and loves to write about it. For additional resources please visit http://www.improveprofitsnow.blogspot.com Send an email to costreduction@aweber.com to get your copy of "16 quick wins to improve your bottom line in 90 days".


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