When it comes to preparing financial statements, there are several options for you depending on the type of system you have in place or the type of organization in question. One of the most important ones is the Cash Flow Statement. A Cash Flow Statement is a statement that shows the exact amount of cash and cash equivalents entering and leaving a company. It simply summarizes how much cash is generated and used during a given period thereby showing you the true movement of cash. In understanding how a Cash Flow Statement works, here are some things you should know.
- It is prepared on actual basis
If you had been preparing a three-statement model, then you would have prepared both an income statement and a balance sheet (statement of financial position.) When preparing an income statement, non-cash items like depreciation, amortization, and a few others are usually put in place. Also, you might have recorded money that you haven’t received. In a cash flow statement, only the actual flow of cash is tracked and recorded.
- Two methods of preparation
From a professional standpoint, there are two methods of preparing a Cash Flow Statement: the indirect method and the direct method. Both methods are used to reconcile other prepared financial statements and the only difference is the way they treat the section on ‘cash flow from operating activities.’ Indirect method feeds from the income statement directly by virtue of the Net Income, while the direct method lists out all the movements in cash as if an income statement wasn’t provided in the first place. Professionally, the indirect method is majorly used.
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- It is different from a cash budget
We often confuse the Cash Flow statement with the cash budget. While they essentially do the same thing, that is track the exact flow of cash, they are prepared in completely different ways for completely different reasons. The first and most important difference is that the Cash Flow Statement is done to record past events while the Cash budget is used for future events. Some companies also prepare cash budgets as their cash flow to simplify the preparation process. However, it is ideal that a company that is just commencing prepares a cash budget. Next, the cashflow statement shows the cash inflows and cash outflows as they relate with a company’s operating, investing and financing activities. A cash budget on the other hand, just shows inflows and outflows.
