Getting a clear picture of the money flowing in and out of your company’s bank accounts is crucial. Not only does this information help you make better business decisions so that you can stay solvent and maintain ongoing operations, but you can also uncover which expenditures and investments aren’t yielding meaningful results, empowering you to be more efficient and productive.
To make the most of your data for cash flow management value, the key is to prepare a proper cash flow statement on a regular basis. This practice will help your CFO and leadership team understand how money goes in and out of your business, allowing you to spot trends and manage them effectively.
Alongside your balance sheets and income statements, the statement of cash flow is one of the three most important financial reports that businesses use.
While you can use several management tools to shed light on your cash flow, it’s crucial to know the common mistakes when compiling your cash flow statement to avoid making them. Read on to learn more about the common mistakes that analysts and bookkeepers make when preparing statements of cash flow, so you can steer clear and ensure accurate, useful financial reporting.
A cash flow statement is a type of financial report that compiles aggregated data about liquid income that a company receives from ongoing operations, including external investment sources.
Your cash flow statement also includes the expenditures that pay for company activities and investments within the given period. It maps out the money spent and received by the company via financing, investment, and operations.
Cash flow statements can be used for:
- Comparing projected income amounts from your budgets with what’s actually happening in the various bank accounts and other holdings
- Helping management make decisions on how changes in liquidity and burn rates should impact the nature and scope of your company’s activities
- Aiding in predicting your future cash requirements, as reconciled with revenue projections
- Helping to evaluate your company’s capability to generate cash in the future, via initiatives both new and old
Below are some of the usual errors that people who prepare cash flow statements can make.
All cash flow necessarily arrives from one of these three categories: operating, investing or financing. A common error is improperly categorizing transactions when creating the cash flow statement, which can lead to an inaccurate report and, in turn, a less useful financial outlook.
It’s therefore critical to understand the categories (including exceptions) and remember that each one is usually associated with a financial statement area that you can track it back to.
Below is a quick breakdown of each category, to help you understand them better and help ensure proper cash flow classification in your worksheets.
- Investing activities. These are generally related to long-term asset changes, such as certificates of deposits, fixed asset purchases, and marketable securities.
- Financing activities. These refer to changes in long-term equity and/or liabilities, including stock issuance and notes payable, all of which are financing sources for company needs. Financing activities also disclose line credit changes (short-term liability), which is not required for the other categories.
- Operating activities. These are usually related to the income statement and current liabilities and assets changes. Operating activities include almost everything else, such as cash flows resulting from operations, even if these don’t have an investing or financing component. For instance, investing in financing or inventory through accounts payable is still considered an operating activity.
Cash flow items are generally reported separately within the cash flow statement. If you bought something and then sold it at a profit, then these transactions should be entered as separate rows on your report.
According to widely accepted accounting trade standards, you can only present cash flows on a net basis when:
- The cash payments and receipts were made on behalf of third parties, which means the reporting entity acts as an agent.
- The cash payments and receipts made are for items with quick turnovers, large amounts, and short maturities, such as when purchasing and selling an investment.
You must present items including finance costs, interest received, and dividends received and paid separately within your cash flow statement instead of showing them as net amounts.
Have you donated services or old office furniture to an organization lately? Companies often give and receive goods “in kind,” consisting of tangible or intangible assets (like services). As non-exchange transactions, these are measured at fair value on the acquisition date.
Similarly, when services in-kind are significant to the company’s operations, and if a value can be determined reliably, the services are recognized at fair value in the statement of financial performance. Goods and/or services in kind, including non-cash donations, are not considered cash transactions. Thus, you should adjust these as non-cash items in your cash flow statement.
Additionally, accepted trade standards dictate that lease payments falling under operating leases be recognized as expenses on a straight-line basis through the lease term. When preparing your cash flow statement, since straight-lining the lease expense doesn’t represent an actual cash payment, you’ll need to adjust for the operating lease payment’s non-cash portion.
One of the most common mistakes when preparing a cash flow statement is transferring interest and foreign exchange differences from liabilities and trade receivables to financial operations.
This is incorrect, since realized foreign exchange differences (on accounts for supplies and services) and paid interest are considered operational activities.
On the other hand, unrealized foreign exchange differences and unpaid interest must be automatically eliminated via a change of the balance of the accounts.
Forgetting to exclude non-cash operations when preparing your cash flow statement can lead to erroneous exclusions from the operating activity.
Some of these non-cash operations that you might forget to exclude in your cash flow statement can include:
- Inventory change following the transfer or receipt of non-cash contributions (in-kind donations and contributions) in the form of inventories
- Investment receivables and liabilities changes, such as unpaid purchases and fixed assets sales
- Offsets of trade receivables and payables
- Liabilities conversions into equity (own fund) and the receivables into shares
Another common mistake when writing a cash flow statement is using increased valuation of fixed assets in the financial year while forgetting to include the increases from transfers from capital work in progress.
You might also unintentionally exclude donations and increases resulting from a financial lease or fixed assets disclosures.
Also, you need to regularly remove the change within the balance of investment liabilities associated with the purchased fixed assets.
While preparing a cash flow statement can be tedious and time-consuming, it doesn’t have to be rocket science.
Learn some of the common pitfalls when preparing your cash flow statement to ensure accurate and correct financial reporting. It makes preparing your cash flow statement more efficient and you avoid doubling back to correct any errors.