How to Manage Cash Flow Statements? (For Startups)

In continuation of our series on “Accounting Basic for Startups”, through this article we would discuss indetail about the importance, method of preparation of Cash Flow statement.Cash Flow Statement – Its Importance

It is a financial tool which forms the basis for the projection of future investing and financing plans of the enterprise, and explains the most important distinction between profits earned and cash inflows. Some of advantages of Cash Flow Statement are listed below:

• Provides summary of the inflows and outflows of cash and cash equivalents.
• Facilitates highlighting the cash generated from operating activities.
• Helps in planning the repayment of short term liabilities and other loan schedule.
• Helps to ascertain the liquid position of the firm and Banks and financial institutions mostly prefer cash flow statement to analyze liquidity of the borrowing firm.
• Gives vital information about the entity’s performance and its major activities during the year.
• It assists in managing cash flows and employment of cost curtailment tools to avoid unnecessary cash payments.

Preparation of Cash Flow Statement

Cash Flow Statement is prepared in an activity format and is basically segregated into four sections: (i) operating, (ii) investing (iii) financing activities and (iv) Cash and Cash equivalents. Usually, the operating activities are presented first, followed by the investing and then financing activities.

A standard template for presentation of activities under different heads is being provided below:

A brief understanding of the following terms is provided below:

(i) Operating Activities:

They are the principal revenue generating activities and involve summarizing day to day sources and application of funds that are generated from the core operations of the business. Operating activities are those which provide either revenue or are the direct cost of producing a product or rendering services and includes the following:

Net From Operations – It is calculated after adjusting following cash income and expenses

• Cash Incomes such as all cash inflows from cash sale, cash received from debtors, commission, fees, royalty, revenue; and
• Cash Expenses outflows including cash purchases, payment to creditors, cash operating expenses, payment of wages, income tax paid

Changes in Net Working Capital – this highlights the increase/ decrease in current assets/ liabilities.

Extraordinary item - For example, bad debts recovered, loss due to fire, winning from lottery etc.

There are two methods of reporting the net cash flow from operating activities can be calculated either through (i) Direct Method or (ii) Indirect Method. They differ only in the manner the information regarding cash flow from operating activities is presented.

Direct Method takes into account actual cash receipts and payments and ignore non cash items like depreciation, preliminary expenses etc. in totality. Indirect method is the most popular method followed by different entities. The net inflow / outflow of funds after taking into consideration the above adjustments, is termed as NET CASH FROM OPERATING ACTIVITIES.

(ii) Investing Activities:

It includes all activities of acquisition and disposal of long – term assets and other investments not included in cash equivalents. For example:

• Cash payments to acquire shares, debt instruments, advances and loans made to third parties, fixed assets (this include research & development costs, cost incurred on intangibles etc.).
• Cash receipts from disposal of fixed assets (including intangibles), shares, repayment of advances, dividend from equity securities etc.

The net of all the transactions covered under this head is termed as NET CASH FROM INVESTING ACTIVITIES.

(iii) Financing Activities:

It includes those activities which result in change in composition and size of owner’s capital and borrowing structure of the organization. Items under the financing activities section includes:

• Cash proceeds from issue of shares, debentures, short or long term borrowings etc;
• Cash repayments of amounts borrowed etc.
• Dividends paid
• Payment of dividend tax

The net of all the transactions covered under this head is termed as NET CASH FROM FINANCING ACTIVITIES.

(iv) Cash and Cash Equivalents:

This includes cash on hand, demand deposits with banks and other short-term, liquid investments, readily convertible into cash and which are subject to insignificant risk of changes in values.

The balance of “Cash and Cash Equivalents” at the beginning of the year is to be added with the aggregate of Net Cash Flow from all the activities, as determined above, to ascertain the Cash and Cash Equivalents available at the end of the year. This closing figure display the actual cash position of the business.

To Conclude - Management of Cash Flow Statement

For businesses, more so for startups, it is paramount to manage cash properly as a profitable business does not really mean cash – rich business, due to timing difference for receivable and payables. For example, in relation to expenses and cash flows, timing difference is the difference between the date when you actually purchased the product or rendered the service and the date when you pay for the same or receive.

For Startups, a cash flow statement should probably be prepared as frequently as possible (monthly) as it complements the income statement and balance sheet.

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