Cash is famously king in both personal and corporate finance. The cash flow statement is often perceived as difficult to understand. By breaking it down into smaller parts and comparing it to a personal monthly cash flow, it becomes an easy-to-understand whole.
The cash flow statement consists of operating cash flow, investing cash flow, and financing cash flow. Simply put, operating cash flow can be imagined as everyday income and expense cash flow. Investing cash flow can be imagined as the cash flow from larger personal investments deviating from everyday life, such as buying or selling a home or car. Financing cash flow can be imagined as cash flow unrelated to everyday income and expenses on the personal side.
Note: The following examples are described according to the most commonly used accrual accounting method.
Operating cash flow (a)
Operating cash flow can be seen as everyday income and expense cash flow. Taxes are paid from salary, which reduces the amount of take-home pay. With the remaining amount, we pay everyday expenses consisting of groceries, children's hobby fees, electricity and water bills, insurance, and rent, etc.
It's clear that if we don't receive our salary on time, it reduces our everyday cash flow for that month. Conversely, if we don't pay our bills on time, it naturally increases that month's cash flow.
Investing cash flow (b)
Investing cash flow can be imagined as the cash flow from larger personal investments deviating from everyday life, such as buying or selling a home. Clearly, buying a home decreases and selling increases cash flow for the month of the transaction.
Financing cash flow (c)
An example where debt increases in everyday life through a mortgage illustrates financing cash flow. In the business world, there is also equity-based cash flow, which can arise from owners capitalizing the company with personal funds, among other things.
A positive financing cash flow for a certain month means, according to the simplified example, that the company has taken more loans or more equity investments have been made than the company has repaid its loans.
Summary
Leaders or finance professionals of successful companies have practically found that bills and salaries cannot be paid with profits shown in financial statements, but only with fully liquid cash reserves. By budgeting the development of the income statement and balance sheet into the future, the company can also assess whether existing cash reserves and operating cash flow are sufficient for repaying loans for future investments.
