Cash flow statement: the essentials of cash flow

Accounting has always been considered the biggest hurdle in business management. A plethora of data, numbers and indicators have to be compiled into a dossier of documents organised in a specific way.

The annual balance sheet provides a reliable overview of the financial dynamics of a company and consists of several components. But the annual financial statements are not the only source of relevant information. In fact, there is one that specifically allows one to monitor the amount of the company's liquid assets.

At first glance, this may appear to be a cumbersome and difficult task, but, in reality, it is not necessarily so. How to do it? The answer is: create a cash flow statement. The cash flow statement will give you a clear view of your business liquidity and cash flow.

But let's take a closer look at what it is.

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What is a cash flow statement?

A cash flow statement, also known as a cash flow statement, is an accounting document that accompanies the annual balance sheet. It is a statement that provides information about the company's cash flow during a specific period of time.

The cash flow statement differs from both the balance sheet and the income statement. However, in conjunction with the latter, it constitutes an essential accounting document for monitoring the state of the company's finances. The cash flow statement, along with the other accounting documents, is also important for possible investment transactions by third party companies. Indeed, through the information disclosed by the cash flow statement, investors can get an idea of your creditworthiness. This consists of your company's ability to be able to repay debts, i.e. credits taken.

In particular, the cash flow statement aims to specify the causes behind a change in a given financial resource over a given time period (corresponding to a financial year). To this end, the document ascertains and illustrates all incoming and/or outgoing movements that have led to an increase or decrease in liquidity during the financial year.

What does the law say?

The cash flow statement was an optional document until 2016. However, with Legislative Decree 139/2015, it became mandatory as of 01/01/2016, for all companies, excluding:

• Partnerships;
• Small and micro enterprises;
• Companies that have an abridged balance sheet regime.

Thus, in addition to the balance sheet, income statement and notes to the financial statements, the file of the annual financial statements must also contain the cash flow statement. The cash flow statement presents itself as an indicator of the financial health of the company.

The cash flow statement, in fact, now appears among the mandatory accounting documents described by the Civil Code, in paragraph 1 of Article 2423. Not only that, it is also defined by Article 2425-ter of the Civil Code.

What is it for? Purpose of the cash flow statement

The purpose of the cash flow statement is to disclose the cause of changes in the company's assets and liabilities in relation to the end of the previous year.

In particular, this is done by presenting specific information about the cash flow. These mainly concern the manner in which financial resources are acquired and utilised, or the causal links existing between the sources and uses of these resources.

Ultimately, the purpose of the cash flow statement is to provide information on the company's liquid assets and their composition at the beginning and end of the financial year. Not only that, it also serves to explain how they change according to the different activities undertaken (investment or financing).

Thus, the cash flow statement, by explaining how the company generated or acquired and used liquidity during a given financial year, informs on:

• The financial means available to the company;
• The changes that these have made to the financial resource taken into account;
• The investment activities of the company;
• The links existing between the investment activities and the related financing;
• The changes in the company's financial situation that occurred during the financial year under consideration.

How to draw up a cash flow statement?

Premises

Article 2425-ter of the Civil Code does not establish a standardised procedure for preparing a cash flow statement. However, there are some guidelines that one should keep in mind before embarking on this task.

First of all, bear in mind that the Civil Code makes explicit the following points that must be expressed by a cash flow statement:

• The amount of available cash;
• Their composition (at the beginning and end of the financial year);
• The changes in cash flow resulting from the company's operations (investment, financing and/or transactions with shareholders).

Then, OIC principle number 10 enjoins that this document must contain information on:

• Sources of financing (both internal and external);
• Investments made by the company;
• Changes in the company's finances and assets.

With this in mind, in order to be able to draw up a good financial statement, it is also necessary to devise certain strategies. In fact, it is good to identify the right tools and establish the right criteria to correctly read the company's financial flow information.

Identify the financial resource

At this point, the first real step in preparing a cash flow statement is to identify the financial resource to be analysed. This rather vague notion encompasses several categories of elements. In fact, it can refer to:

• Net working capital(NWC);
• Cash (cash, balance of accounts receivable and payable, securities realisable on demand).

The choice of the financial resource of reference must, of course, depend on the cognitive objective pursued by the company.

Choose a scheme

The cash flow statement admits the possibility of being drawn up in two formats, based on the following layouts, provided for by Accounting Standard OIC 10:

• The direct method, which involves the presentation of each individual inflow and outflow (receipts or payments);
• The indirect method, which involves a calculation made on the result for the year (net profit or loss from the income statement). To the latter are added the costs that generated the cash flows and subtracted the revenues that did not result in cash flows).

Regardless of the method chosen for preparing the cash flow statement, the end result should be the same. Thus, it is quite indifferent which system is chosen for the development of the cash flow statement. However, while it is true that most entrepreneurs prefer to use the indirect method, accountants continue to recommend applying the direct method.

Choose the format to use

Regardless of the method used to develop your financial statements, it is advisable that each document be organised into three parts. These refer to the areas associated with cash movements during the financial year. These are:

1. Operating activities, i.e. the day-to-day business income and expenditure (e.g. revenue from sales or various payments);
2. Investing activities, i.e. transactions involving larger cash outflows for longer-term purchases such as for real estate or equipment;
3. Financing activities, which include, for example, cash inflows from loans or the raising of equity funds, or outflows from the payment of dividends to investors.

Choose how to record data

Once you have gathered all the necessary information and have organised the right format for your financial statement, it is time to actually implement it.

How to do it? The operation is simple and involves two possibilities:

• You can devote yourself to the manual compilation of a pre-established template, chosen according to the type of your company and your needs, or
• You can choose to rely on accounting software that offers you the possibility of automatically generating the document with all the necessary information. In this case, the software will do the calculations for you and even plan future statements on a weekly or monthly basis.

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What are the advantages of preparing a financial statement?

In conclusion, it can be said that the cash flow statement has a particular informative relevance. This statement, in fact, indicates the financial health of a company and thus offers the possibility of a more comprehensive assessment of its economic situation. This is because the cash flow statement makes it possible to trace the primary causes that have determined a company's progression in one direction rather than another.

Thus, in the final analysis, the cash flow statement is not only an important document at the legal level, but is also very useful at the internal company level. Indeed, it allows one to understand the contribution of each business activity and, ultimately, of each management area to the increase or decrease in cash flows.

In practice, this allows a company to have relevant information on:

• Its liquidity availability;
• Its possibility of self-financing;
• Its ability to meet short-term financial commitments.

This information can bring the company significant advantages, such as:

1. Potential for improvement and optimisation of operating activities in subsequent financial years. In fact, the cash flow statement makes it possible to understand what exactly has led to a profitable situation for the company, or has, on the contrary, penalised it.
2. Identify the driving business areas in the context of cash generation and/or absorption and, therefore, implement them accordingly.
3. Organise a more efficient business plan based on an awareness of one's real cash possibilities.

Thus, the cash flow statement can be regarded as a good flow analysis tool. This statement is important because it allows a better understanding of the company's dynamics and prepares the company for all kinds of future eventualities.