These are another popular statement of figures you may see in a set of business accounts that can be helpful to explain the actual cash flow of a business. This difference between cash and say profit on paper is critical, and often missed by people.
In short, this is to do with what actual money you have in the bank at a certain point in time, often at the last day of the accounting year – which may be different to what ‘profit’ you have in the accounts when you take the reality of trading at that point into account.
Let’s say you run a shop and you have £10,000 profit showing on the books, but only £8,000 money in the bank at that time. The £2,000 difference is not ‘missing’ as in you will not benefit or receive it, but more a case of it is tied up with others at that point in time.
So, you might have people owing you money then, which will physically be received in your bank the following month. And you may have bills to pay that have not yet gone out.
Taking these adjustments off each other simply changes the cash to £8,000. If all these were resolved on this day, then it would be £10,000, but in real life there will always be loose ends, and accounts have to adjust for this accordingly in the official version, which cash needs to eventually catch up with.
In terms of some of the official ways these are noted in these Statements of Cash Flow, these include:
• There will be different categories of costs such as operating activities, investing activities, and financing activities
• You have direct and indirect figures to hand, which basically begin with income and costs from the accounts and what changes you need to make to reflect the actual cash-reality at that time
• You may need to add back in expenses that have been assumed in the accounts which are not reality now, for example general expenses, prepaid costs like insurance and salaries, and Accounts Payable (monies you have assumed need to be paid out)
• Likewise, you can deduct off items such as Accounts Receivable (monies you have assumed to be received as income), and increases from say inventories and expenses
• Other expenditure items like buying new equipment and an pre-payments need to also be noted in order to adjust to the cash situation
• A final comparison to what actual money is in the bank and the change in the last period can also show how his all links together
Therefore, once you get the gist of what this Statement of Cash Flow is trying to say it can help provide a reflection of what the actual flow of cash is within a business, as although it may be profitable on paper the issue of not having money moving quickly or sufficiently through the accounts can cause issues.
Once established, you can then compare the actual cash figure with the profit one, and then trail back and see what the changes are that has caused the difference.