Why Is Creating a Cash Flow Statement Important?

Importance of Creating a Cash Flow Statement

Last Updated May 7, 2024

The importance of a cash flow statement is something every business owner needs to recognize as they manage the financial aspects of their company. By creating an accurate cash flow statement, you can gain a clear understanding of your business’s current financial position and take steps to improve your cash flow.

With that being said, let’s recap what a cash flow statement is, what numbers belong on this document, and why it’s so pivotal for not just business owners but investors and stakeholders as well.

What Is a Cash Flow Statement?

A cash flow statement is, as you might have guessed, a summary of a business’s cash flow. More specifically, this essential financial document summarizes the total amount of cash and cash equivalents going in and out of a company during a set time period, such as a month or quarter.

The purpose of a cash flow statement is to give business owners an overview of their business’s current financial picture and determine whether their current cash flow management and accounting practices are working as intended.

What Goes on a Cash Flow Statement?

To create a cash flow statement, start by documenting the total balance in your business’s bank account at the start of the time period you’re measuring. You’ll next calculate all cash inflows of money received from client payments, investments, financing activities, and so on.

Next, you’ll measure cash outflows—the payments you made during the same time period. You’ll subtract the total of your cash outflows from your cash inflows and opening balance to determine your ending balance.

Why Is Creating a Cash Flow Statement Important?

A cash flow statement tells you if you are earning more money than you are spending, or vice versa. But cash flow statement importance goes well beyond this big-picture snapshot. There are several uses of statement of cash flows that can help your business.

If you’re wondering why a cash flow statement is important for a business, the following reasons provide compelling evidence as to why this financial statement is so essential.

Offers Better Insights Into Spending and Your Cash Balance

Cash flow statements provide a comprehensive picture of your spending activities—including payments that aren’t necessarily going to show up on a profit and loss statement. Items like loan repayments often only show up on the cash flow statement, which makes this financial statement a must for fully understanding how you are spending and earning money.

Your cash flow statement tells you what your current cash balance is and whether your income and spending levels are creating an excess of cash or contributing to a deficit.

Guides Short-Term and Long-Term Planning

With a full understanding of your financial picture, you can implement better short-term and long-term financial planning to meet all of your business’s obligations and increase profits. Cash flow statements help you project future cash flow, identify activities that can help improve cash flow (such as optimizing inventory processing or payments receivable), and determine if your cash plans are delivering the intended results.

With a cash flow statement, you can see what is and isn’t working and adjust your financial practices accordingly.

Helps Investors and Stakeholders Evaluate Your Business

The importance of cash flow statements to investors cannot be understated. Your cash flow statement is used by investors and stakeholders to evaluate your working capital and the overall health of the business.

For investors, the information contained within the cash flow statement will affect whether they decide to invest in the first place. Stakeholders who are already invested will use a cash flow statement to offer guidance to improve a business’s operations.

What Investors and Stakeholders Look for in a Cash Flow Statement

A statement of cash flows gives investors and stakeholders a clear understanding of how money is moving in and out of a company they are considering investing in. For example, historic cash flow statements help potential investors project what the business’s future cash flow will look like. They will look at a business’s liquidity and solvency, changes in the balance sheet, and information about cash-generating activities. They will pay extra close attention to how you are earning and spending money in each area of the business.

Investors will compare your business’s statements with cash flow statements of other companies to evaluate the earning potential of a business within its industry. This information helps them project whether the business represents an investment that is likely to succeed or whether the business is at risk of going under.

The importance of cash flow statements to stakeholders is particularly worth noting. Stakeholders look at similar items in the cash flow statement to evaluate the quality of the company’s earnings, as well as to evaluate repayment options for long-term debt and predict future cash flow.

Investors and stakeholders will often look at the company’s cash flow ratio—the total cash flow from its operations divided by its current liabilities—to evaluate the health of the business and decide if it is a good investment. The higher the ratio, the better!

In-Summary: Why Creating a Cash Flow Statement Is Important

There’s a reason the cash flow statement is considered one of the three essential financial statements that every business owner should create and analyze regularly. A statement of cash flows will reveal areas affecting your cash flow the most, allowing you to improve cash flow moving forward into future financial periods.

As a business owner, you might naturally feel like there are more important tasks than analyzing your finances—tasks that are more directly correlated to driving sales. But remember that performing a cash flow analysis will help you understand how to free up cash moving forward, which in turn will lead to business growth and expansion.

Importance of a Cash Flow Statement FAQs

What do you need to make a cash flow statement?

To make your cash flow statement, you’ll need to gather all relevant financial documents tracking the money going in and out of your business. This includes balance sheets, profit and loss statements, and any other transactions (including non-cash transactions) for the time period you wish to measure.

What does a cash flow statement show?

The purpose of a statement of cash flows is to show whether your company is effectively generating cash. It shows how much cash (and cash equivalents) enter and leave your business during a specific time period.

How often do you need to make a cash flow statement?

It’s best to prepare cash flow statements each month since many business expenses are paid monthly. The significance of a cash flow statement is that it will quickly provide an accurate and up-to-date view of your current cash flow management. Because of this, monthly statements are best so you can take quick action if something needs to change.

Is a cash flow statement one of the three essential financial statements?

Yes. Cash flow statements are considered one of three essential financial statements for businesses, along with income statements and balance sheets.

Why is cash flow so important to a business?

Cash flow measures the amount of money entering and exiting the business. Positive cash flow is needed to manage daily operations and operating costs, including paying employees, buying inventory, and paying taxes. Because of this, the statement of cash flows is useful because it tells you if your business has a positive or negative cash flow.