(FREE) The Basics of Cash Flow Statements, Part 2
Investing in your business's future. Financing. Owner's distributions
Commentary directly from the video (regular type)
My commentary (italics)
Continued from Part 1:
Cash flow from investing
This is where cash in and outflows from the buying or selling of (long-term/fixed) assets and investments are reflected.
CASH FROM (USED IN) INVESTING =
Purchase/sale of property or equipment
+/- Acquisitions/sale of divisions or companies
+/- Purchase/sale of other investments
+/- Any other investing adjustments
For a more in-depth explanation of each factor that affects cash flow - see the free The Basics of Cash Flow Statements, Part 2 spreadsheet.
Purchase/sale of property or equipment
Purchasing long-term, fixed assets such as property or equipment can have an enormous negative effect on your cash flow. It is, however, an INVESTMENT in your future capacity and therefore should increase your future cash flow from operations.
Of course, selling those same assets would result in a cash inflow.
Effect on cash: Decrease (purchase) or increase (sale).
Acquisition/sale of companies/divisions
Like long-term, fixed assets, an investment in another company would likely involve a significant cash outflow. Selling off a portion of your business, on the other hand, would likely involve a significant cash inflow.Â
Effect on cash: Decrease (acquisition) or increase (sale).
Purchase/sale of other investments
Typically, your company should reinvest in itself through the purchase of (fixed) assets, employees, marketing, etc. However, if you were to purchase stocks, real estate, or some other contemporary investment, the cash used in that transaction would be reflected here.
As you expect, the liquidation of those investments would result in an increase in cash.
Effect on cash: Decrease (purchase) or increase (sale).
Cash flow from financing
This section captures cash flows from raising, borrowing, and repaying capital (cash).
CASH FROM (USED IN) FINANCING =
Loan (bond) proceeds
- Loan (bond) PRINCIPAL repayment
+/- Stock issued or repurchased
+/- Owner’s distribution (dividend) and contribution
+/- Any other financing adjustments
For a more in-depth explanation of each factor that affects cash flow - see the free The Basics of Cash Flow Statements, Part 2 spreadsheet.
Loan (bond) proceeds
When a company borrows from a bank (or issues bonds) it receives a cash inflow.
Effect on cash: Increase.
Loan (bond) PRINCIPAL repayment
Loans, of course, need to be repaid with interest. Note that the repayment of interest is captured on the income statement and, therefore, reflects in the operations section. The repayment of principal is NOT captured elsewhere and therefore must be accounted for here.
Effect on cash: Decrease.
Stock issued or repurchased
If you issue shares of stock in your company to investors - you do so to increase your cash balance. Conversely, if you were to repurchase those shares, your investors are probably going to want to be paid in cash.
Effect on cash: Increase (issued) or decrease (repurchased).
Owner’s distribution (dividend) and contribution
Many small business owners opt to compensate themselves (partially or completely) with an equity distribution. This is only reflected on the balance sheet, NOT the income statement. Therefore it is not reflected in the cash flow from operations.
If the small business owner pays themselves a salary, that WOULD be reflected as an expense (like all other employee wages) on the income statement and would, therefore, also be reflected in cash flow from operations.
If the owner contributes capital (cash) to the business, the effect is the same as the issuance of stock. The cash balance will go up.
Effect on cash: Decrease (distribution/dividend) or increase (contribution).
Conclusion
The sum of the three sections will tell you the net change in cash for the period. This should EXACTLY match the CHANGE in your cash balance (from the balance sheet, this period minus the last period). If it doesn’t, then something was not accounted for.
Again, use the free The Basics of Cash Flow Statements, Part 2 spreadsheet to better understand how all of these factors affect YOUR cash flow. Keep in mind that this spreadsheet is a simplified representation of your cash flow statement. Not every account/factor that might affect cash flow is included.
Comment below
Do you review your cash flow statement as often as your income statement or balance sheet?
Do you compensate yourself more with a salary or with owner’s distributions? Why?