Cash flow statements and accounts receivable (2024)

Accounts receivable represents the outstanding invoices generated by a company for goods or services sold on credit. A higher accounts receivable amount indicates that customers are yet to pay for the products or services they’ve purchased. While a surge in receivables may paint an optimistic picture of sales growth, the delay in payment collection can negatively impact cash flow.

Read our article What is accounts receivable for more information.

Cash flow is a financial metric that gauges a company's ability to generate and utilize monetary resources in a specific period. It provides insights into the inflow and outflow of cash and cash equivalents resulting from the company's operations, investments, and financing activities.

Cash flow is essential for meeting day-to-day operational expenses, investing in growth opportunities, repaying debts, and returning value to the stakeholders. A positive cash flow indicates that a company has adequate funds to cover its expenses and can maintain its liquidity, whereas a negative cash flow may signal financial challenges or unsustainable business practices. Consequently, businesses must manage their cash flow effectively to ensure long-term stability and financial health.

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The cash flow statement (CFS), also known as a statement of cash flows, is a key financial report that documents a business's inflows and outflows of cash and cash equivalents (CCE). The CFS helps measure a business's capacity to settle debt obligations and cover operational expenses as an indicator of the company's ability to manage its cash resources.

The cash flow statement works in tandem with the balance sheet and income statement to offer a comprehensive overview of a company's financial position.

There are four main reasons that businesses, large and small, need cash flow statements:

1. Gauge financial health: The CFS acts as a diagnostic tool, illuminating the actual financial position of a business. It reveals a company’s ability to generate enough cash to cover expenses and pay debts.
2. Monitor cash inflows and outflows: To buffer the cash crunch, businesses must assess their cash flow. It's all about knowing when there's plenty of cash and when there's a drought. Cash flow statements become a roadmap, guiding businesses to use their money responsibly by monitoring cash flow from operating, investing, and financing activities.
3. Make informed decisions: Making business decisions without examining cash flow statements can be disastrous. The cash flow statement's metrics enable decision-makers to examine trends and adjust accordingly. This data can significantly aid in planning for expansions or preparing for unforeseen business challenges. To gain deeper insights into your cash flow statements, consider integrating your accounts receivable processes with an ERP such as NetSuite or Quickbooks for enhanced financial visibility and control.
4. Acquiring loans and investments: Financiers examine cash flow statements prior to lending money or injecting capital into a business, as they are a clear indicator of how well the business manages its financial resources. A robust cash flow statement showcasing a healthy financial position could be the key to unlocking funds for business growth.

A business's cash flow is a measure of its ability to meet financial commitments, such as paying salaries, rent, and other operational expenses. When accounts receivables increase, the cash inflow decreases, creating an inverse relationship between the two variables. This negative effect on cash reserves can hinder a company's ability to reinvest in the business, settle debt obligations, and sustain growth.

To maintain a healthy cash flow, businesses must prioritize effective accounts receivable management strategies. This includes implementing credit control policies, closely monitoring overdue balances, and offering flexible payment terms to incentivize customers to make payments promptly. By diligently managing accounts receivable, a company can minimize the negative impact on cash flow and create a more stable financial foundation for growth and success.

Since changes in accounts receivable directly impact a company’s cash flow statement, it’s vital to understand how fluctuations in accounts receivable influence cash flow.

As we’ve covered, accounts receivable is the money owed by customers for goods or services sold on credit. When receivables increase, cash inflow decreases, which is reflected in the cash flow statement's operating activities section. On the other hand, when receivables decrease, cash inflow improves, resulting in higher net cash from operating activities.

These fluctuations influence a company's working capital management and overall cash flow statement. Therefore, businesses should regularly review their accounts receivable strategies, such as credit policies, payment terms, and collection efforts, to ensure accurate cash flow representation.

To calculate cash flow, first determine the timeframe for which you want to calculate the cash flow. Typically, cash flow is calculated monthly, quarterly, or annually. You’ll need to gather all financial records for the selected timeframe, including income statements, balance sheets, and cash flow statements.

There are three primary sections in a cash flow statement: operating activities, investing activities, and financing activities. Each of these sections is calculated based on different sets of financial transactions.

Operating activities include the company's core business operations, such as revenues generated from sales, payments made to suppliers, employee salaries, and taxes paid. To calculate operating cash flow, first find the net income by subtracting total expenses from total revenues. Then, adjust the net income for non-cash items such as depreciation and changes in working capital. You can get these numbers from the company's balance sheets and income statements.

Investing activities represent cash flows from purchasing or selling long-term assets, such as machinery, equipment, and real estate. To calculate cash flow from investing activities, subtract the cash used for purchasing the assets from the cash received from selling assets during the given period.

Financing activities involve the inflow of cash from investors, such as banks and shareholders, and the outflow of cash to shareholders as dividends as the company generates income. To calculate cash flow from financing activities, add the cash inflows from issuing stocks, bonds, or other forms of debt, and subtract the cash outflows like dividends and repayment of debt principal.

Finally, add all the cash flows from operating, investing, and financing activities together to get the total net cash flow for the given timeframe. A positive net cash flow indicates that the company has sufficient cash to cover its expenses, while a negative cash flow could signal potential financial difficulties.

Changes in accounts receivable must be recorded in cash flow on a balance sheet. A drop in accounts receivable implies increased cash from consumers paying off credit accounts. The amount of decreased accounts receivable increases the company's net sales.

Net sales, however, must be reduced by the amount of any increases in accounts receivable. This is due to the fact that, despite being considered revenue, accounts receivable amounts are not cash.

Monitoring and managing changes in accounts receivable plays a critical role in maintaining an accurate cash flow statement. Businesses must adopt best practices and maintain transparent communication with customers to facilitate timely payments and prevent cash flow-related issues. By keeping a pulse on accounts receivable, a company can maintain a healthier cash flow and continue investing in its growth and success.

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