Generally accepted accounting principles (GAAP) describe how businesses use their resources and account for them. In general, businesses will classify their assets into two categories: working capital and inventory. They will use these assets to create an asset cycle which shows how resources are transformed into goods or services that have a direct relationship to the sale of products and/or services. The cycle is also called the cash flow system. A cash flow statement, therefore, is used to track and record the flow of funds throughout a business’s operation.
A cash flow statement, therefore, is crucial for a company to understand its total income and expenses and to measure its progress in making money. It also provides a means of measuring the profitability of business operations. In the United States, the Financial Accounting Standards Board (FASB) has issued Accounting Standards requiring companies to prepare and submit a cash flow statement. These standards specify the basic requirements and format for the document.
Most small businesses, especially those that do not employ the services of a professional accountant, cannot produce an accurate cash flows analysis. On the other hand, even medium-sized and large businesses can have problems in tracking their cash flows. For these businesses, it is helpful to depend on the daily activities of the business. Bookkeeping, which includes recording daily financial transactions, is the basis of any reliable study of the accounting records.
To generate a cash flow statement, businesses have to record all of their financial transactions in the daily journal. Such records include total revenue earned, expenses incurred, the cash in and out of the reserve, current and long-term debts, stockholders’ equity, net income and dividends received. The total revenue and net income should be recorded in the account that tracks revenues. The expenses incurred should be recorded in the account that tracks expenses.
Current and long-term debts are liabilities that must be reported in the account that tracks assets. A company’s inventory consists of machinery, land, equipment and supplies that are used in the production of products. When a company incurs a liability, it means that it has a debt to replace the goods or services acquired. The goods or services may be replaced with new goods or services, or they may be retained and sold. Businesses have to report any sale of inventory with cash paid for and with accrued interest as well as dividends received.
Cash-flow forecasts, which are part of the financial statements of a company, provide information about how much cash is coming in and how much is going out. This allows the managers and owners of a company to plan for a rainy day or to meet their budget obligations. Cash flow forecasts are also useful in predicting how much revenue a company will earn. Cash flow forecasts are based on assumptions about how much income the business will realize in one year, how much it expects to earn in the following year and what kind of effect, if any, the weather will have on business revenues and expenses.
Cash-flow forecasts are more accurate than balance sheets because they do not include all of a company’s assets. All of the costs and revenues stated in the statement are factored into the costs and revenues statement. A cash flow statement only shows the current balance as of the last day of the year. In order to obtain a more accurate picture of a company’s activities, the operating, investing and financing activities of the company should be included in the statement. Some companies use other types of accounting systems such as balance sheets, profit and loss statements and many use a combination of the two systems.
If you are a small business that does not generate or need a lot of cash flow to operate, then you do not really need to have a cash flow statement unless you own unfinished goods or equipment that you need to sell in the future. Many companies, though, have customers who want products or services now but have no place to store or buy them. These customers may be waiting for their credit cards to reload or debit cards from their accounts. In this case, cash flow is very important for a small business to remain profitable.