The Statement of Cash Flows is one of the four main financial statements that companies usually prepare at the end of the accounting period (other reports: Balance Sheet, Income Statement, and Statement of Retained Earnings). The Cash Flow Statement provides an accurate description of the amount of cash receipts, cash disbursements, and changes in cash balances for one year. This report is prepared by calculating changes in cash balances from operational activities, investments, and loan withdrawals/payments. The increase or decrease in the cash balance for one year will be added to the last year's ending cash balance to calculate the ending balance of cash and cash equivalents at the end of the year.
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Part 1 of 4: Calculating the Beginning Cash Balance and Cash Equivalents
Step 1. Determine the ending cash balance of the previous period
If the company has made a Cash Flow Statement for the previous period, you can get the ending cash balance through this report. If not, you will have to calculate it yourself using the cash balance information in last year's Balance Sheet. Add up the cash and cash equivalent balances that can be converted into cash within one year. Cash equivalents consist of money market securities, time deposits, and savings in bank accounts.
Step 2. Add up the cash and cash equivalent balances
Look up cash and cash equivalents on the Balance Sheet. For example, at the end of last year, the company had a cash balance of Rp.800,000 in cash. In addition, there are money market securities of Rp. 2,500,000, time deposits of Rp. 1,500,000, and savings in bank accounts of Rp. 1,200,000.
- Add them all together to determine the last year's ending cash balance.
- Rp800,000 (cash) + Rp2,500,000 (money market securities) + Rp1,500,000 (deposit) + Rp1,200,000 (savings) = Rp6,000,000 (last year's ending cash balance).
Step 3. Determine the beginning cash balance for the current year
The balance at the end of last year will be the beginning balance for the current year. Using the example above, the balance at the end of last year was Rp. 6,000,000. So, this figure is the beginning balance for the current year.
The beginning balance of cash and cash equivalents for the year is Rp6,000,000
Part 2 of 4: Calculating the Amount of Cash from Operating Activities
Step 1. Prepare a net income figure
Net income is the total revenue after deducting expenses, depreciation, amortization, and taxes. This is the company's profit for one year or the money that remains after all expenses have been paid. You can see this figure in the Income Statement.
Using the example above, the company's net income in the report is $8,000,000
Step 2. Calculate depreciation and amortization
Depreciation and amortization costs are non-cash costs that reduce the value of an asset over time. Depreciation and amortization costs are calculated based on the asset's cost and economic life. However, these costs must be added to the cash balance because there are no cash disbursements transactions.
Continuing the example above, the company's depreciation and amortization costs are reported at CU4,000,000. Thus, $4,000 must be added to the cash balance
Step 3. Calculate payables and receivables
Debt is money that must be paid by the company to creditors. Receivables are company money borrowed by debtors to purchase goods or services. In the Income Statement, accruals of payables and receivables are recorded when the transaction occurs, regardless of whether or not money is paid or received. So, the accrual of non-cash transactions must be taken into account in making a Cash Flow Statement.
- The balance of receivables at the end of last year is the balance of receivables at the beginning of this year. For example, the beginning balance of accounts receivable is $6,000. At the end of the year, the balance of receivables became Rp. 8,000,000 or increased by Rp. 2,000,000 in a year. Receivables have been recorded as company income at the time of the sale transaction, but have not been received in cash.
- Therefore, the increase in receivables during the current period indicates that the company has used funds from cash to fund sales transactions so that this increase in receivables must be deducted from the cash balance. A decrease in accounts receivable balance means there are payments from customers that must be added to the cash balance.
- Based on the example above, the balance of receivables that increased by Rp. 2,000,000 must be deducted from the cash balance because the funds have not been deposited by the customer to the company.
- The balance of the debt is reduced by Rp. 1,000,000. This amount must be added to the cash balance because the increase in the debt balance does not occur in payment transactions by the company.
Step 4. Calculate the amount of cash generated from operational activities
Prepare a net income figure, add it to depreciation and amortization, then subtract the accrual of accounts receivable and payable.
- Rp8,000,000 (net income) + Rp4,000,000 (depreciation and amortization expenses) - Rp2,000,000 (increase in receivables) + Rp1,000,000 (increase in debt) = Rp11,000,000 (cash balance generated from the company's operational activities).
- Net cash obtained from the company's operational activities is Rp11,000,000.
Part 3 of 4: Calculating Cash Flows from the Company's Investments and Financing Activities
Step 1. Evaluate long-term capital investment
Long-term capital investment is the company's funds used to purchase equipment in order to produce goods or services. When a company buys equipment, there is a transaction from one asset (cash) to another asset (equipment). Thus, the purchase of equipment is a use of cash. Similarly, if a company sells equipment, there is an exchange between assets (equipment) into other assets (cash or receivables arising from the sale of equipment). If the company purchases equipment for cash during the period of preparing the Cash Flow Statement, this expense must be taken into account.
Step 2. Calculate the impact of the financing activity
Funding activities can be done by withdrawing or repaying short-term debt and long-term debt, issuing and buying back shares, and paying dividends. These activities can increase or decrease cash flow. Withdrawing loans and issuing stock will increase the cash balance, while repaying debt and paying dividends will reduce the cash balance.
Step 3. Make adjustments due to investment and funding transactions
Reduce cash balances if the company purchases equipment, repays debt, or pays dividends. Add cash balances if the company issues stock or draws out new loans. Let's say this company makes the following transactions:
- Purchased a new computer and built an assembly line for $4,000 which had to be deducted from the cash balance.
- Withdraw short-term debt of Rp. 500,000 and issue shares of Rp. 250,000 thereby increasing the cash balance.
- In addition, the company repays long-term loans and pays a dividend of IDR 2,000,000 which must be deducted from the cash balance.
- -Rp4,000,000 (purchase of capital goods) + Rp500,000 (increase debt) + Rp250,000 (issue shares) - Rp3,000,000 (return long-term loan) - Rp2,000,000 (pay dividends) = -Rp8,250,000 (decrease cash balances during the period due to investing and financing activities).
- The cash balance adjustment due to investing and financing activities is –Rp8,250,000.
Part 4 of 4: Calculating the Ending Cash Balance and Cash Equivalents
Step 1. Determine the amount of increase or decrease in the cash balance
This step is taken to find out whether there is an increase or decrease in cash balances during the current year. Prepare the total cash flow figures from operating activities and then add them with adjustments to cash flows from investing and financing activities. The end result is an increase or decrease in cash balances during the year.
- In the example above, the cash flow from operating activities is Rp11,000,000.
- The change in cash from investing and financing activities is –Rp8,250,000.
- The increase in cash balance is Rp11,000,000 – Rp8,250,000 = Rp2,750,000.
Step 2. Compute the ending balance of cash and cash equivalents
Prepare the last year's ending cash balance number and add it to the increase/decrease in cash during the current year. The result is a cash and cash equivalent balance at the end of the year.
- In the example of the company we are discussing, last year's ending cash balance was Rp. 6,000,000.
- The increase in cash this year is Rp2,750,000.
- The ending balance of cash and cash equivalents for this year is Rp.6,000,000 + Rp.2,750,000 = Rp.8,750,000.
Step 3. Use the cash flow statement to evaluate the company's financial health
The cash flow statement eliminates accrual, depreciation and amortization transactions thereby providing accurate information about cash inflows and outflows. This report provides investors with a clear picture of the company's profitability and operating success.
- An increase in cash balance usually indicates that the company is operating efficiently and is responsible for managing investment and financing activities.
- A decrease in cash balances can be an indication of problems in the company's operations, investing, or financing activities. In addition, this information is an indication that the company must reduce certain costs in order to improve its financial condition.
- Remember that cash flow analysis is only a small part of how to maintain a company's financial health. A decrease in cash balance may occur due to a large investment for the future development of the company. On the other hand, a decrease in cash balance may reflect management's negligence in reinvesting company funds.
