Join Rudolph Rosenberg for an in-depth discussion in this video Introduction to the cash flow statement, part of Financial Literacy: Reading Financial Reports.
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- [Voiceover] The cash flow statement is the last document of the financial statement, and is the one that is the most grounded in reality. Here, there's nothing more to know than if money is or is not in the bank. You could wonder why there's a need to have such a document when you already have a bank statement, a balance sheet, and an income statement. Well, first of all, the income statement does not report cash. It reports revenue. It reports income, but not cash. For the bank statement, and the balance sheet, which do report cash, it is done in a way that does not give a sufficient level of detail to enable a good understanding of the key levers the company needs to use to ensure its success, and sometimes, its survival.
In the cash-flow statement, cash is reported over a period of time, a year for example. And you can follow its evolution between a starting date and an end date. Just as the 1st of January up to the 31st of December. In a cash-flow statement, the main categories are, the beginning balance, cash from operations, fixed asset purchase, net borrowing, income tax paid, sale of stock, and the ending balance. The biggest reason for having a cash flow statement is that there's a big difference between the accounting view of the company and its cash reality.
Both views are correct and useful to managing the company. And both show the company through different lenses, which complete each other. The profitability of the company is as we've seen, the difference between its revenue and its expenditures. In the income statement, we always assume that they both happen at the same time to ensure we can review the profitability of each of our actions. But when it comes to spending money or collecting it, the timing of it can be, and usually is, very different from that income statement view.
To sell your product, you need to purchase material and produce goods well in advance, which therefore implies that you have actually spent the money well before it is accounted for in the income statement. And as we have already seen, revenue is very different from cash, which can be received a long time after the sale has been made. As a concrete example, if you produce your goods one month before selling them, and you receive payment one month after selling them, you can end up with two full months between the time you invest the company's money and the time you get the return.
During that time, you need to be able to continue to fund the operations of the company, either with money that has been saved, or with a loan, and the bigger the orders you receive, and the more the situation creates pressure for the company. If you think of it, this is critical for successful companies that can receive increasing orders as they become more successful and need to find a way to fund the gap that exists between production and payment. This is why it is sometimes necessary to find financial partners to help you go through that high pressure time and not turn down orders.
It is therefore critical for a company to be able to manage its cash and have a thorough understanding of its inflows and outflows of money. Gaining that understanding enables the company leaders to understand what its vulnerabilities are and to take appropriate actions well in advance of their occurrence.
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- What is a financial statement?
- Reading the balance sheet
- Understanding depreciation, liabilities, and equity
- Reading the income statement
- Understanding revenue, costs, profitability, and net income
- How cash flow works
- Analyzing financial documents with context<br><br>
- The PMI Registered Education Provider logo is a registered mark of the Project Management Institute, Inc.