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We’ve seen a lot of queries lately asking various questions about the Statement of Cash Flow so we’re going to take this opportunity to demystify this alien evil. We’re going to use a basic Statement of Cash Flow for Little Johnny’s Lemonade Stand that he set up in front of his house. For further information on how to prepare a statement of cash flow or to better understand cash flow and how cash flows through a business, check out Understanding Cash Flow from InstantController.com.
Cash Flow from Operations is where the meat and potatoes of the company are. A company can have a down month or year so the Net Income could be abnormally low, but the Cash Flow From Operations will tell the whole of the story of the direction of the company. You will want to at least see a positive number in the Net Income and Cash from Operations.
The Statement of Cash Flow always begins with the Net Income number. This is because the Income Statement is the basis for cash flow through the business – if you don’t make money on the income statement, you won’t normally have cash flow to worry about for very long. When looking at a Statement of Cash Flow, Net Income should be the first number you look for because it tells the story of whether the company is profitable. Little Johnny’s Lemonade made a net of $5 for the day – not bad for the little entrepreneur. Then add back into the net income the expenses that really didn’t cost cash – just depreciation for most companies. This is because depreciation is a non-cash expense – the cash was paid out when the asset being depreciated was purchased. In Johnny’s case, he only had $0.50.
Items that go in this section are changes in current assets (excluding cash) and current liabilities – the higher volume accounts that cash churns through. If an asset increases, it is a use of cash – it’s an asset to the business, but it takes cash to pay for it. By the same token, increases in liabilities are a source of cash because you are delaying the payment of a bill and you have the opportunity to use that cash for something else.
In Johnny’s case, his friend Henry said he would pay Johnny tomorrow for some lemonade today and he drank eight cups at $0.25 each! Thirsty bugger! So the 8 times 0.25 equals $2.00 in AR that Johnny has. While he had the sale, he still doesn’t have the cash until tomorrow when Henry pays him.
Mr. Wilson across the street said Johnny could have all the lemons he wanted for $3.00 and he could pay him tomorrow, after he had made his money selling the lemonade. So Johnny had the $3.00 in Lemons, but he didn’t have to pay for them on the spot, so this is a source of cash because Johnny can now use that $3.00 to buy Dixie cups for the lemonade! Johnny’s Accounts Payable at the end of the day is $3.00 to Mr. Wilson.
For the first day of operation, Johnny’s Cash Flow from Operations is Adjusted Net Income of $5.50 – $2.00 due from Henry + $3.00 payable to Mr. Wilson, for a total of $6.50. Any prepaid expenses would also be listed in Cash from Operations with the same rules as any other asset – increase = use of cash, decrease -= source of cash.
Cash From Investing is the section where any long term assets show their effects. For most companies, this is only Fixed Assets (gross). At the beginning of the day Johnny had to spend $10.00 on PVC lawn furniture to set his stand up with, so he has $10.00 tied up in fixed assets.
Cash from financing is where the effects of debt and equity show up. If you issue stock, the cash received for the stock would show up in this section as well as any proceeds received from the sale of bonds or from obtaining cash financing. In this case, Johnny was only 7 years old and had to get $20.00 in venture capital from Dad. It sounded risky, but Dad chose to roll the dice any way and loan him the $20.00.
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Statement of Cash Flow |
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Cash From Operations |
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Net income |
5.00 |
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Add: Depreciation |
0.50 |
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Adjusted Net Income |
5.50 |
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Decrease in AR |
(2.00) |
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Increase in AP |
3.00 |
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Cash from Operations |
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6.50 |
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Cash from Investing |
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Decrease in Fixed Assets |
(10.00) |
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Total Cash from Investing |
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(10.00) |
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Cash from Financing |
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Loan from Dad |
20.00 |
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Total Cash from Financing |
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20.00 |
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Calculated Change in Cash |
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16.50 |
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Beginning Cash |
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– |
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Ending Cash |
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16.50 |
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Change in Cash |
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16.50 |
From all of this, Johnny had an increase in cash of $16.50, which he had in his cash box at the end of the day. To prove this out, we can do it by looking at the actual receipts and disbursements:
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Direct Method |
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Loan from Dad |
20.00 |
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Lawn Furniture |
(10.00) |
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Cash Sales |
6.50 |
** |
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16.50 |
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Cash Sales |
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Adj Net Income |
5.50 |
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Cost of lemons |
3.00 |
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Henry didn’t pay |
(2.00) |
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6.50 |
For further information on how to prepare a statement of cash flow or to better understand cash flow and how cash flows through a business, check out Understanding Cash Flow from InstantController.com.
— John