Cash Flow Statement: Analysis and Interpretation of your Financial Information

Cash flow statement, or CFS, is applied in analysis and interpretation of a firm’s financial information. This helps run a business.

The DFC is important for analyzing the cash flow result in a given period, showing whether the company has earned more than it spends and whether it is in a favorable financial situation.

Learn more below and learn how to prepare a Cash Flow Statement correctly. Check out what you will learn here:

What is DFC and what is it for?

Abbreviated for “Cash Flow Statement”, this tool is an accounting report that records all the cash inflows and outflows of a company during a period, specifying the origin of each transaction and showing at the end the result of all movements.

Cash inflow refers to receipts from products and/or services sold to others, as well as assets, in addition to the receipts from investments or loans. Cash outflights refer to payments from the suppliers, debts repayments, distribution of the dividend, among others.

This report intends to be able to reflect a given period of a company in terms of the cash generating ability. In that perspective, it is used commonly by investors as a measure of whether they should provide money to the business to invest.

It will also be a basis on which the Balance Sheet and the Income Statement will be prepared, also termed as DRE statement. It can help identify or detect possible accounting fraud or misrepresentation in the books and records of the company.

Why is DFC important?

Cash flow analysis can provide further details on the company’s performance and what is going where and from where. It is also useful to provide a better security level for money-based decision-making, including loan-taking or financing requests.

With the DFC, it is also possible to identify moments when the cash flow ends up positive and assess the best investment for this “extra” money. Likewise, it is possible to foresee periods of low cash flow, when money may be lacking, thus preparing the company to face difficulties without any scares. It is like a large financial X-ray of the business.

What are the advantages of DFC?

With DFC you gain more financial control in cash flow management, which also brings more security, credibility and transparency to the business.

This allows for route adjustments, if necessary, actions such as promotions, launches of new products and services or even the withdrawal of an item that is not selling well.

With this knowledge about the company’s real financial situation, investors or credit institutions can open more doors and offer more opportunities for the business, optimizing its growth.

What is the difference between DFC and DRE?

The Cash Flow Statement (CFS) and the Income Statement ( IS ) are accounting reports prepared in conjunction with the Balance Sheet, but which are recorded differently by the company’s accounting department.

This is because the DFC records the cash basis, while the DRE records the accrual basis.

In short, while the DFC records all cash inflows and outflows — analyzing the financial health of the business — the DRE records not only cash movements. In other words, expenses and income are also included in this analysis, ultimately bringing the net result of the business (which can be profit or loss).

How to prepare an efficient DFC for your company?

There are two methods for preparing the DFC: direct and indirect. Understand how each of them works:

Direct method

The direct method requires considering the company’s gross inflows and outflows of resources, which means using real data on customer receipts and payments for expenses and suppliers. This method uses information from accounting records.

Indirect method

In the indirect method, the variation in equity accounts related to the Income Statement is considered, through the adjustment of net profit.

What is the structure of a DFC?

The DFC report must be structured into three different activities and, finally, bring its result:

1. Operational Activities

Operating activities are the expenses and costs that the company needs to incur in order to perform its services or produce the goods that will be sold, in order to generate revenue.

2. Investment Activities

Investment activities, as the name suggests, are initiatives related to investments made by the company with the money left in cash after covering all its expenses, linked to its long-term assets.

3. Financing Activities

Financing activities are the loans that the company needed to take out or money that the partners injected into the business when the final cash flow was negative.

4. Result

Finally, the total result of the DFC will be the sum of the results of each of the three activities described above, plus the difference between the initial and final balance of the period analyzed. After all, did the cash flow end in the negative (loss) or in the positive (profit)?

Step by step: how to make a DFC

  1. Choose the period to be analyzed;
  2. Identify the revenues and expenses related to each of the three activities described above in the Income Statement and Balance Sheet;
  3. Identify investments and financing and the movements of accounting accounts. Accounts will not appear on the balance sheet if they do not have a beginning and ending balance;
  4. Organize the information by summarizing the cash flow;
  5. Classify this movement into one of three activities: operational, investment or financing.
  6. Here ends the DFC by the direct method, which is the most used in the market.
  7. To perform the DFC using the indirect method, follow the previous steps and change only the operating activities section, also remembering that there will be no difference between the investing and financing activities. It is necessary to identify whether the activities are adding to or subtracting from the cash value and insert the variations in the operating accounts of the Balance Sheet.

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