What is Financial Flow?

Financial flow also known as cash flow is the statement of all the cash inflow and outflows within the organization. It is prepared by calculating the difference between the opening financial balance and the closing balance. Businesses earn money from sales and spend it to run the business. Preparing a financial flow statement is essential for measuring the liquidity and overall financial performance of a company.

A positive figure in the financial flow indicates that the company has increasing liquid assets. This ensures that the company can pay all its debt and can return money to shareholders. Companies that have a good financial flow can stay strong in the downturn. Negative cash flow often indicates the risk of bankruptcy.

Financial flows are analyzed by using the cash flow statement. A standard financial statement stores cash sources and expenses over a specified period. Managers, analysts, and investors use this document to find how well a company earns money and pays debts and expenses. Along with the balance sheet and income statement, the cash flow statement is also an important document for a company.

Why Is Financial Flow Analysis Important?

Analyzing financial flow indicates how much money the company has to run business operations. It helps you understand if your business can pay for its expenses and generate enough cash to continue operation. Financial flow is important to meet all your expenses as well as plan for the future.

A financial flow statement will give you better information about your current spending and earnings. An accurate cash flow statement will help you to find the exact available amount of funds. You can make better decisions by managing cash flow carefully. 

If you are unable to pay your debt, it will damage your business relationship and your overall reputation. Financial flow shows your current financial condition so that you can keep yourself prepared. 

Types of Cash Flow Statement

The Cash flow statement shows cash earned from the business and cash used in operations. There are the elements of a cash flow statement. 

Cash Flows from Operations (CFO): Cash flow from operations or operating cash flow gives us information on money flows that directly come from the production and sale of goods. CFO indicates the availability of enough funds coming in to meet all the operating expenses. Operating cash flow is calculated by subtracting operating expenses from the cash received from sales. Cash spent and earned from the company’s products or services is listed in this section. Revenue from the sale of goods and services, interest payments, income tax payments, salary and wages and suppliers payments are included in this CFO. 

Cash Flows from Investing (CFI): Cash flow from investing reports the amount of generated cash or spent from various investment-related activities. Assets purchase, investments in securities, selling securities or assets included in investing activities.  

Investing activities are important for growth and capital. Stock valuation is the popular measure of capital investment. However, companies with a good amount of capital expenditures are in a state of growth. 

Cash Flows from Financing (CFF): Cash flows from financing give insights of the cash used to fund the company. Transactions including issuing debt, equity, and paying dividends represent financing activities. Investors get insight into a company’s financial strength by cash flow from financing activities. 

How to Calculate Cash Flow Statement

A Cash flow statement can be calculated using a direct or indirect method. Each of those methods gives the actual record of each financial flow. However, the cash flow from operations is only visible in the direct method. 

Direct cash flow method: The direct method records all the cash flows from the daily operations of a business. This includes both the cash inflow and outflows. The method is appropriate for small businesses. 

The direct cash flow method may look easier at the beginning. This method includes adding all the cash inflows and outflows together as they occur. But, adding all the flows together and listing each cash payment can be time-consuming. There is also a high chance of error in case of missing a single receipt. Besides, most businesses use the accrual accounting method and it is suitable with the indirect method.

Indirect cash flow method: In this method, cash flow is calculated by adjusting the net income received from the income statement. All the non-cash transactions are listed here, such as losses from the sale of fixed assets, inventory, accounts receivable, depreciation, etc. Those non-cash items represent the company’s change in assets and liabilities on the balance sheet. 

Most of the accountants like to use the indirect method as it is simple to prepare. In the indirect method, the cash flow statement is prepared using information from the income statement and balance sheet. Since accrual accounting is used by most businesses, the balance sheet and income statement will show figures that are consistent with this approach.

It is very easy to calculate the net cash flow. You have to subtract the total cash outflow from the total cash inflow to get the cash flow.   

The Formula of Net Cash Flow is: Total Cash Inflows – Total Cash Outflows  

The balance between cash inflow and outflow is very important to maintaining a healthy business.  

Statement of Cash Flow Using Accounting Software

The manual method for creating cash flow statements using spreadsheets can be a time killer as it involves data entry and calculations. Using accounting software allows you to do this more efficiently. It saves plenty of time when creating a statement of cash flow. During a crisis period, stakeholders may request cash flow statements for specific periods, accounting software can easily generate those reports. 

Accounting software can benefit your cash flow in the following ways:

• Accounting software can prepare faster Invoices. This helps a business maintain healthy relationships and track all the cash inflows automatically. 
• It provides real-time visibility. It allows companies to monitor their cash flow for a specific period.
• Automated software reduces fraud and errors as it is not prepared manually. Companies can avoid costly mistakes.
• Automated software is cost-effective. Businesses can reduce the costs related to manual processes such as printing, data entry, storage, etc.

Limitations of Statements of Cash Flow

The cash flow statement gives a business insight, but it cannot draw overall the financial picture of the company. To get a complete view of the company’s financial status, analysts use data from the balance sheet and income statement. The balance sheet represents a firm’s financial assets and debt for a specific period and the income statement shows a firm’s financial transactions over a specific time. However, the cash flow statement only includes cash inflows and outflows. Transactions that do not directly affect cash are excluded from the cash flow statement. As cash is the primary focus of the cash flow statement, it ignores the basic accounting accrual concept. 

The Cash flow statement is an important document for a company. It answers whether the business has enough liquid money to pay its debts and to buy new assets. By balancing cash inflows and outflows, you can ensure the seamless daily operation of your company, at the same time as building sufficient reserves to weather peaks and troughs in sales, late invoice payments, or unexpected expenses.