Cash flow: where is your money?

Make a profit and still go bankrupt?
Do you want insight into your company’s liquidity? Then you need to find out where your money is coming from and what it is being spent on. Otherwise, it may happen that your company makes a profit according to the income statement, while you have almost no cash in cash because you have to finance your growth by investing in inventories and receivables.

If you do not look for additional sources of funding in time, you will no longer be able to meet your payment obligations. You run the risk of going bankrupt profitably.

Cash basically comes in four different ways:

  • Sales of products and services;
  • sale of assets;
  • indebtedness;
  • Deposits on existing or new shares.

Why make a cash flow statement?
A cash flow statement provides insight into where your money came from and what it was spent on. The overview answers the following questions:

  • How much money was generated by the corresponding profit at the end of the period considered?
  • How does cash flow differ from profit?
  • What else has your company converted to liquid assets?

Paper profits
Suppose your company bought a commercial building a few years ago for € 750,000. According to the latest assessment, the property is now worth 1.5 million euros. Due to this increase in value, it is possible to include a profit of € 500,000 in the income statement.

Keep in mind, however, that this is only a paper profit, not available as cash. The business premises were to be sold for this. The increase in cash and cash equivalents as a result of revaluation of the property is therefore zero.

Balance movements
Changes in liquidity arise as a result of income (cash flows) and expenses (cash flows). Both lead not only to revenue and expenses, but also to balance sheet movements. Examples are:

  • Payments from customers. These lead to an increase in balances and a decrease in receivables;
  • Repayment of loans. This leads to a reduction in balances and a reduction in debt.

Using the various balance sheet movements and data from the income statement, you can explain changes in your liquid assets in a cash flow statement. This overview is derived from the State of Origin and the Use of Resources (SHBM), which was previously widespread. In a SHBM, the term ‘cash flow’ is often used. This is generally described as the net profit plus the depreciation of property, plant and equipment in the period in question.

You can check where financial resources come from and what they have been spent on by changes in the items in the balance sheet and the income statement over the period over which the SHBM has been calculated.

Cash flow: 3 divisions
When preparing a cash flow statement, companies generally use a classification based on the following categories: operationalinvestment– and financing activities† These are a source of both incoming and outgoing cash flows.

cash flow from operating activities
Cash flows from operating activities can be calculated in two ways: according to the direct or indirect method. With the direct method, you derive your cash flows directly from the cash giro book. With the indirect method, you take the profit as a starting point as shown in the income statement.

Operating liquidity shows the extent to which your company has been able to convert its profits over the past period into cash, including depreciation and changes in the value of current assets and current liabilities.

Calculation of operating cash flows
You calculate your cash flow from the following steps:

  1. Add the depreciation to the net result. The sum of both is the cash flow.
  2. Add the changed vendor amounts and the outstanding cost items together. This gives the net change in short-term debt.
  3. Add the changed amounts for receivables, inventory and prepaid expenses. The sum is the net change in current assets.
  4. Subtract the net change in current liabilities (step 2) from the net change in current assets (step 3). The result is the change in net working capital.
  5. Finally, the adjusted net working capital (step 4) is deducted from the result of step 1. The result is the operating cash flow.

So the cash flow of the operation is not what many people think is the same as net profit plus depreciation.

You need to take that into account To determine the cash flow from operating activities, you must consider the following factors:

  • Depreciation† These are added to the total cost. This is not an attack on your liquid assets because the amount has already been paid in previous years when purchasing fixed assets (a building, a machine).
  • Debtors† If products are sold on account (credit), part of the turnover will not be paid at the end of the period. An increase in receivables compared to the previous year results in a negative cash flow for your business.
  • stock† You often have more products in stock than you sell. This can be detrimental to cash flow. If you expand your stock, some of the liquid assets will remain fixed in this unsold stock.
  • Costs paid in advance† Sometimes you pay certain costs in advance. Money is therefore paid for costs that do not count as costs for the period in question.
  • Creditors and costs still have to be paid† Your company not only buys some products and services on account, but also has other costs that are paid later. The company therefore has costs in the period for which no expenses have yet been incurred.

Cash flow from investing activities
The operating cash flow is the first part of the cash flow statement. The second part shows the investments made in your business. Investments are needed to also be able to generate cash flows in the future. It can be replacement investments, but also expansion investments to realize growth.

Part of the operating cash flow is invested by the company in fixed assets during the year. The remaining cash flow is referred to as the free cash flow. In fast-growing companies, this operational cash flow may even prove insufficient to finance necessary investments. In such a case, the company will have to raise capital to finance investments.

But as an entrepreneur, you not only invest, you also sell from. That is, you dispose of fixed assets that have reached the end of their economic life and can no longer be used with profits. These assets are exchanged for new fixed assets, sold for a relatively small amount (the residual value) or simply thrown away.

Cash flow from financing activities
The third part of the cash flow statement provides an overview of the financing of your business. These are the cash flows that result from the raising and / or repayment of long-term capital and profit distributions to shareholders.
Debts that are repaid naturally have a negative impact on liquid assets.
The last line of the cash flow statement shows the net increase or decrease in a company’s liquid assets.

Anyone who has ever done bookkeeping knows that this is not the most fun job and can also be time consuming. Fortunately, you are not alone. The tools below can help you with this:

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