In one way or another, we often find ourselves dealing with our finances. That is, attempting to maximize the value of our hard-earned money. However, for financial success and stability to be achievable, we need to understand the significance of financial statements. One of the most important financial statements is the cash flow statement.
Every Nigerian who aims to effectively manage his/her finances needs to understand how the cash flow statement works. In this article, you will get a thorough overview of a cash flow statement and how it can help you make wise financial decisions. As you tag along, you’ll also discover how to maintain cash flow in your business.
Table of Contents
What is a Cash Flow Statement?
A cash flow statement is a type of financial statement that records how much money comes in and goes out of a business over a given period, usually a year. That is, it reveals the inflow and outflow of cash in a business.
On the other hand, a cash flow formula or statement presents a clear picture of how money enters and exits a business or a person’s financial system. Owing to this, it helps an individual or entity to easily identify the solvency, liquidity, and financial stability of an organization or business.
A cash flow formula also helps to manage personal finances, plan investments, and make wise business decisions. Thus, it is important to understand this statement well.
Read also: An Insightful Guide to Asset Management for Nigerian Business Owners
5 Key Elements of a Cash Flow Statement
We need to be familiar with the elements of the cash flow formula to fully understand its implications on our finances. Mastering these elements will also guide us on how to maintain cash flow well in a business.
Let’s take a quick look at some key elements of the cash flow statement:
This section features the inflow and outflow of cash from regular business operations, such as sales, purchases, and operating expenses. For individuals, it includes earnings from jobs, business income, and recurrent costs like rent, utilities, and groceries.
This category includes cash flows associated with the acquisition or disposal of long-term assets like real estate, automobiles, or investments like stocks and bonds.
Investing activities may also involve purchasing and selling shares, investing in mutual funds, or buying and selling real estate.
In this case, the financial manager makes financing decisions, also known as capital budgeting decisions. Capital budgeting decisions aim to allocate capital or commit funds to long-term assets that would yield benefits in the future.
These operations involve cash flows from outside funding like loans, equity investments, or dividend payments. Financial activities could also involve getting a mortgage, getting a personal loan, or getting income from assets.
In a situation whereby the management has to determine where, when and how to acquire funds to meet the firm’s investment, financial decisions are made.
Cash flow from operations
This section discloses the net worths generated by regular business operations. It demonstrates a person’s or organization’s capacity to earn income from their core operations, giving a good sign of financial stability.
Cash flow from investing and financing activities
This section includes cash flows from investing and financing activities. We can determine how much a person uses to finance his/her growth internally or through borrowing money from other sources by examining these flows.
Advantages of Understanding a Cash Flow Statement
Understanding how the cash flow formula works can be beneficial for personal finance and businesses. Let’s look at 4 major advantages of understanding a cash flow statement:
Better financial decision-making
By looking at cash flow statements, people can assess their income sources, spot unnecessary expenses, and make smarter decisions regarding their finances. This includes decisions about saving, investing, and spending.
The cash flow formula also aids in setting priorities and judicious resource allocation, resulting in better financial outcomes.
Cash flow statements give businesses and individuals a way to evaluate their capacity for responsible debt management.
People can check if they have enough money to pay off their debts and keep a good credit score by keeping track of their cash inflows and outflows.
Effective budgeting and financial planning
These are built on the foundation of cash flow statements. Firms can plan for major expenses, set realistic financial goals, and create strategies for savings and investments by analyzing historical cash flows.
Evaluating investment opportunities
By understanding a cash flow statement, firms are better equipped to assess investment opportunities.
Individuals can also evaluate the profitability, liquidity, and potential hazards of potential investments by examining the cash flows they generate before making an investment decision.
Effective Ways to Maintain Cash Flow
Forecast your cash flow
You can forecast your cash flow by keeping track of your income and outgoing costs. Creating precise cash flow helps to estimate any upcoming deficits or surpluses.
With this proactive strategy, you can anticipate possible problems and take the required steps to avoid them and maintain a constant cash flow.
To shorten the time it takes for your clients to pay you, practice effective invoicing and collection procedures. Send accurate and timely invoices.
Be clear about your payment terms, and take immediate action if a payment is late. To expedite the receivables process, think about providing rewards for in-time payments or putting in place automated payment solutions.
Manage payables effectively and efficiently
To improve and maintain cash flow, bargain good terms of payment with your suppliers. Attempt to postpone payments while preserving positive interactions. However, be careful not to endanger supplier relationships by constantly postponing payments.
Keep an eye out for places where you can reduce prices without sacrificing the quality of your goods or services. Look for ways to save costs by negotiating better prices with suppliers, using different vendors, and so on.
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Create a cash flow budget
To predict accurately your anticipated inflows and outflows of cash over a given period, create a cash flow budget. This will support successful resource planning and allocation. Moreover, it will ensure that you have adequate cash on hand to meet costs and take advantage of growth opportunities.
The Cash Flow Formula
The cash flow formula offers a straightforward foundation for computing and comprehending your company’s cash flow. It also enables you to correctly track your cash flow and make data-driven decisions to sustain your organization. You can derive this formula from the data in your financial accounts, particularly the “balance sheet” and “income statement.”
Below is an explanatory equation:
Cash flow = Operating cash flow + investing cash flow + financing cash flow
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Keeping a positive cash flow statement is essential to the success of your company. You can improve your cash flow and guarantee financial stability by adopting finance management tactics like monitoring, forecasting, effective receivables and payables management. Spending control, cash flow budgeting and other practices featured in this guide can also help you maintain cash flow effectively.
Article Edited by Priscilla Ajayi.
Blessing Chinaza is a financial copywriter, Financial Manager and Marketer.
She writes high converting sales copy, ad copy, Email copy and product description for individuals and brands, that compels their target audience to take immediate action, which in turn drives massive sales. She is an avid reader and loves to explore areas in finance.
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