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How to apply cash flow principles to your financial life

Financing is the process of collecting funds to invest to ensures proper utilization. Proper financing required to follow 6 core principles of finance to ensure the maximization of benefit. Briefly, finance is the management of funds. The person who is responsible for managing the fund is well known as financial managers.

Principles of Finance

Principles act as a guideline for the investment and financing decision. Financial managers take operating, investment, and financing decisions. Some of this related to the short term and some long term. The 6 Principles of Finance everyone should Know whether it is for individuals or organizations.

How to apply cash flow principles to your financial life

There are six principles of finance you must know

  1. The Principle of Risk and Return
  2. Time Value of Money Principle
  3. Cash Flow Principle
  4. The Principle of Profitability and liquidity
  5. Principles of diversity and
  6. The Hedging Principle of Finance

Risk and Return

The principle of Risk and Return indicates that investors have to conscious both risk and return, because higher the risk higher the rates of return and lower the risk, lower the rates of return. For business financing, we have to compare the return with risk. To ensure optimum rates of return investors need to measure risk and return by both direct measurement and relative measurement.

Time Value of Money

This principle is concerned with the value of money, that value of money is decreased when time passes. The value of $1 of the present time is more than the value of $1 after some time or years. So before investing or taking funds, we have to think about the inflation rate of the economy and the required rate of return must be more than the inflation rate so that return can compensate for the loss incurred by the inflation.

Cash Flow

The cash flow principle mainly discusses the cash inflow and outflow, more cash inflow in the earlier period is preferable than later cash flow by the investors. This principle also follows the time value principle that’s why it prefers earlier more benefits rather than later years benefits.

Profitability and Liquidity

The principle of profitability and liquidity is very important from the investor’s perspective because the investor has to ensure both profitability and liquidity. Liquidity indicates the marketability of the investment i.e. how easy to get cash by selling the investment. On the other hand, investors have to invest in a way that can ensure the maximization of profit with a moderate or lower level of risk. This is best overlooked by a qualified accountant to ensure all tax obligations are met.

Diversity

This principle helps to minimize the risk by building an optimum portfolio. The idea of a portfolio is, never put all your eggs in the same basket because if it falls then all of your eggs will break, so put eggs by separating in a different basket so that your risk can be minimized. To ensure this principle investors have to invest in risk-free investment and some risky investment so that ultimately risk can be lower. Diversification of investment ensures minimization of risk.

Hedging

Hedging principle indicates us that we have to take a loan from appropriate sources, for short-term fund requirement we have to finance from short-term sources and for long-term fun requirement we have to manage fund from long-term sources. For fixed asset financing is to be done from long-term sources.

Finally, if you have a basic understanding of finance and its principles then you will be able to take financial decisions effectively. And there is a higher possibility to become financially gainer.

Written by
Md. Nahian Mahmud Shaikat
Financial Analyst
Email: [email protected]
ResearchGate: Nahian Mahmud Shaikat

Investors know that the first requirement to investing in Philippine stock market is cash flow.

Have you ever heard yourself saying “If I only had some cash now, I’d surely take this buying opportunity!”

If your answer is a resounding echoing yes, then it probably only means two things – you do not use this first tip & trick in investing or you’re really lacking in your cash flow.

To solve the latter, it’s important to assess at which phase of financial life you’re in now and take the appropriate course of actions. If you remember, in the last blog I shared some life investments you can take that will give you the best returns. This time, we’ll take a look at the phases of life under a financial magnifying glass.

Phases of Life

When you were a baby, I assume that you didn’t do anything to provide for yourself. Your parents, or whoever took care of you that time, did all the work to provide your basic needs. In fact, not just needs but protection and love as well. So it’s like all your needs were well taken care of without you being aware of it and without you doing anything to earn it. That was so easy, and I miss it. HAHA. Well, not really, since my mother still serves me my cup of coffee whenever I request for it, even if I’m already 23 years old. She keeps on reminding me to eat my meals and take care of my health when I seem to be unstoppable at work. Acts of love I’m sure.

The second phase is when you start to work for money. This begins when you sign your first job contract and formally enter the labor force of the Philippine republic. It’s an ecstatic moment for many. You say, finally, you can now have that “control” of your life.

Personally, the time I received my first pay became the richest point in my life. HAHA. I never thought that I would feel that way that day. I was caught shocked when I checked my account balance in an ATM during the first cutoff. Deep inside I was asking, “Is that balance amount I saw real?” HAHA.

Now that’s what you call active income. Active income is a kind of income you earn out of your active work. A more general definition is that an active income is what you get when you exchange your time for money. And since each of us has limited time, that automatically translates to limited active income.

Simply stated, without your work, you’ll receive nothing. Zero active income.

Now after just few months of working, I began to be questioning, “If I have a monthly payroll schedule, that means I only earn a dozen times in one whole year.” JUST TWELVE TIMES IN 365 DAYS. And it somehow pinched a part of my pride. I felt it was too few. HAHA.

Going back, of course there can be instances when these two phases can coincide at the same time. Like during my college, wanting to make my last undergraduate year more productive, I applied as a student assistant in ES (Engineering Science) department giving me the opportunity to work for money while receiving my regular baon. In effect I have active income at play with passive allowance. What I like most about it however is the fact that I was able to meet a lot of students who were under the classes I assist in. I guess teaching is really my destiny. HAHA

But back to the point, for the majority of people, they’re content with these two phases of life. Worse, their view is narrowed down to these two. They keep on relying on an active income only. If they stop working, they stop the flow of their income. They stop serving food on the table. Or sending their kids to school. Or sending OFW padala to Philippines.

Are you like that?

If yes, be afraid then. When you do it, you’re like flying in a plane with only one wing. One wrong mistake and you’re doomed to a financial disaster. And the sad part of it is that it’s not only you, but all your dependents that will be affected.

The two more phases of the wealthy

Wiser people choose to add more phases to their lives and have a good flight in their financial journey.

They add two more.

Phase 3 is when money starts to work for you.
This is primarily made by investments including that in stock market giving you an easy access to enter this gateway of your life. By buying stocks, you become part-owner of giant companies and thus participate in its growth. You are able to own big businesses without the hassle, risk and complications of building it from scratch. You’re leveraging on the expertise of giant businessmen to make your money work for you. Your assets begin to generate more assets. Any paper asset that does this is better than an asset resting in peace in some other place

Finally phase 4 is when a system works for you.
You build a system that will replicate what you would otherwise personally do. This could be in the form of a business or technology.

In a business, people starts again to work for you, but this time, people no longer treat you as a baby but as a boss. By setting up a business that hires employees, you’re able to earn as a result of your brilliance in putting up a business and letting other people do the hard work for you.

Or let’s say that you’ve put up Online Marketing, for example, that will make the selling job automatic versus hiring sales agent. Now it’s no longer people working for you but technology designed to do the job. All you need to do is to invest that initial time to put it up at the start and it keeps on working for you 24 hours a day thereafter. Cool right?

That’s only a rough version on how you can possibly increase your cash flow.

The goal then is to create multiple streams of income. You should have not only a diversified investment portfolio but also diversified sources of income. When you do this, you position yourself to better improve your financial life.

Hope this lights up a bulb in you. Have a great week!

Have fun investing (by increasing your cashflow)!

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How to apply cash flow principles to your financial life

How to apply cash flow principles to your financial life

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In the previous course, you learned financial statement analysis and how to make estimate of future financial status. In this course, you are going to learn capital budgeting. That is, how to make an investment decision. You would like to select the best project among various projects you can take. Then, you need to know the criteria. In this course, you are going to learn investment decision criteria such as NPV and IRR, which are most popular decision rules. Using financial analysis and discounted cash flow method, you can make pro forma financial statement and estimate project cash flows. Then, you apply investment criteria to determine whether to invest or not. After learning how to apply NPV and IRR method to investment decision, you are going to learn how to evaluate NPV estimate and scenario, what-if analyses and break-even analysis. In addition to NPV and IRR, you are going to learn Payback period method and Profitability method to determine whether to invest or not when there is a political risk or capital rationing.

Рецензии

In this module, you will learn how to estimate project cash flows using Excel. Overall, project cash flow analysis is similar to firm-level cash flow analysis. However, there also exist some unique features of a project cash flow analysis, which requires us to study the project cash flow principles.

Skylar Clarine is a fact-checker and expert in personal finance with a range of experience including veterinary technology and film studies.

What Is Cash Flow Financing?

Cash flow financing is a form of financing in which a loan made to a company is backed by a company’s expected cash flows. Cash flow is the amount of cash that flows in and out of a business in a specific period.

Cash flow financing—or a cash flow loan—uses the generated cash flow as a means to pay back the loan. Cash flow financing is helpful to companies that generate significant amounts of cash from their sales but don't have a lot of physical assets, such as equipment, that would typically be used as collateral for a loan.

Key Takeaways

  • Cash flow financing is a form of financing in which a loan made to a company is backed by the company's expected cash flows.
  • Cash flow financing—or a cash flow loan—uses the generated cash flow as a means to pay back the loan.
  • Cash flow financing helps companies that generate cash from sales but don't have a lot of assets to be used as collateral for a loan.

Understanding Cash Flow Financing

If a company is generating positive cash flow, it means the company generates enough cash from revenue to meet its financial obligations. Banks and creditors analyze a company's positive cash flow as a means of determining how much credit to extend to a company. Cash flow loans can be either short term or long term.

Cash flow financing can be used by companies seeking to fund their operations or acquire another company or other major purchase. Companies are essentially borrowing from a portion of their future cash flows that they expect to generate. Banks or creditors, in turn, create a payment schedule based on the company's projected future cash flows as well as an analysis of historical cash flows.

The Cash Flow Statement

All cash flows are reported on a company’s cash flow statement (CFS). The cash flow statement records the company’s net income or profit for the period at the top of the statement. Operating cash flow (OCF) is calculated, which includes expenses from running the company, such as bills paid to suppliers as well as operating income generated from sales.

The cash flow statement also records any investing activities, such as investments in securities or investments in the company itself, such as purchasing equipment. And finally, the cash flow statement records any financing activities, such as raising money through lending or issuing a bond. At the bottom of the cash flow statement, the net amount of cash generated or lost for the period is recorded.

Projecting Cash Flows

Two areas that are important in any cash flow projection are a company’s receivables and payables. Accounts receivables are payments owed from customers for goods and services sold. Accounts receivables might be collected in 30, 60, or 90 days in the future.

In other words, accounts receivables are future cash flows for goods and services sold today. Banks or creditors can use the anticipated amounts of receivables due to be collected to help project how much cash will be generated in the future.

A bank must also account for the accounts payables, which are short-term debt obligations, such as money owed to suppliers. The net amount of cash generated from receivables and payables can be used to forecast cash flow. The amount of cash being generated is used by banks as a way to determine the size of the loan.

Banks might have specific guidelines regarding the extent of positive cash flow needed to get approved for the loan. Also, banks might have minimum credit rating requirements for a company’s outstanding debt in the form of bonds. Companies that issue bonds are assigned credit ratings as a way to assess the level of risk associated with investing in the company’s bonds.

Cash Flow Loan vs. Asset-backed Loan

Cash flow financing is different from an asset-backed loan. Asset-based financing helps companies to borrow money, but the collateral for the loan is an asset on the balance sheet. Assets that are used as collateral might include equipment, inventory, machinery, land, or company vehicles.

The bank puts a lien on the assets that are used for collateral. If the company defaults on the loan—which means they don’t pay back the principal and interest payments—the lien allows the bank to legally seize the assets.

Cash flow financing works in a similar fashion in that the cash being generated is used as collateral for the loan. However, cash flow financing doesn't use fixed assets or physical assets.

Companies that typically use asset-based financing are companies with a lot of fixed assets, such as manufacturers, while companies that use cash flow financing are typically companies that don't have a lot of assets, such as service companies.

Discounted cash flow (DCF) is an analysis method used to value investment by discounting the estimated future cash flows. DCF analysis can be applied to value a stock, company, project, and many other assets or activities, and thus is widely used in both the investment industry and corporate finance management.

How to apply cash flow principles to your financial life

Summary

  • Discounted cash flow (DCF) evaluates investment by discounting the estimated future cash flows.
  • A project or investment is profitable if its DCF is higher than the initial cost.
  • Future cash flows, the terminal value, and the discount rate should be reasonably estimated to conduct a DCF analysis.

Understanding DCF Analysis

DCF analysis estimates the value of return that investment generates after adjusting for the time value of money Time Value of Money The time value of money is a basic financial concept that holds that money in the present is worth more than the same sum of money to be received in the future. . It can be applied to any projects or investments that are expected to generate future cash flows.

The DCF is often compared with the initial investment. If the DCF is greater than the present cost, the investment is profitable. The higher the DCF, the greater return the investment generates. If the DCF is lower than the present cost, investors should rather hold the cash.

The first step in conducting a DCF analysis is to estimate the future cash flows for a specific time period, as well as the terminal value of the investment. The period of estimation can be your investment horizon Investment Horizon Investment horizon is a term used to identify the length of time an investor is aiming to maintain their portfolio before selling their securities for a profit. An individual’s investment horizon is affected by several different factors. However, the primary determining factor is often the amount of risk that the investor . A future cash flow might be negative if additional investment is required for that period.

Then, you need to determine the appropriate rate to discount the cash flows to a present value. The cost of capital is usually used as the discount rate, which can be very different for different projects or investments. If a project is financed through both debt and equity, the weighted-average cost of capital (WACC) approach can apply.

Calculation of Discounted Cash Flow (DCF)

DCF analysis takes into consideration the time value of money in a compounding setting. After forecasting the future cash flows and determining the discount rate Discount Rate A discount rate is the rate of return used to discount future cash flows back to their present value. It is often a company’s Weighted Average Cost of Capital (WACC), , DCF can be calculated through the formula below:

The CFn value should include both the estimated cash flow of that period and the terminal value. The formula is very similar to the calculation of net present value (NPV), which sums up the present value of each future cash flow. The only difference is that the initial investment is not deducted in DCF.

Here is an example for better understanding. A company requires a $150,000 initial investment for a project that is expected to generate cash inflows for the next five years. It will generate $10,000 in the first two years, $15,000 in the third year, $25,000 in the fourth year, and $20,000 with a terminal value of $100,000 in the fifth year. Assuming the cost of capital Cost of Capital Cost of capital is the minimum rate of return that a business must earn before generating value. Before a business can turn a profit, it must at least generate sufficient income is 5%, and no further investment is required during the term, the DCF of the project can be calculated as below:

Without considering the time value of money, this project will create a total cash return of $180,000 after five years, higher than the initial investment, which seems to be profitable. However, after discounting the cash flow of each period, the present value of the return is only $146,142, lower than the initial investment of $150,000. It suggests the company should not invest in the project.

Pros and Cons of Discounted Cash Flow (DCF)

One of the major advantages of DCF is that it can be applied to a wide variety of companies, projects, and many other investments, as long as their future cash flows can be estimated.

Also, DCF tells the intrinsic value of an investment, which reflects the necessary assumptions and characteristics of the investment. Thus, there is no need to look for peers for comparison.

Investors can also create different scenarios and adjust the estimated cash flows for each scenario to analyze how their returns will change under different conditions.

On the other hand, the use of DCF comes with a few limitations. It is very sensitive to the estimation of the cash flows, terminal value, and discount rate. A large amount of assumptions needs to be made to forecast future performance.

DCF analysis of a company is often based on the three-statement model. If the future cash flows of a project cannot be reasonably estimated, its DCF is less reliable.

Innovative projects and growth companies are some examples where the DCF approach might not apply. Instead, other valuation models can be used, such as comparable analysis Comparable Company Analysis This guide shows you step-by-step how to build comparable company analysis (“Comps”) and includes a free template and many examples. and precedent transactions.

Additional Resources

Thank you for reading CFI’s guide to Discounted Cash Flow (DCF). To keep advancing your career, the additional resources below will be useful:

Cash flow — For other uses, see Cash flow (disambiguation). Accountancy Key concepts Accountant · Accounting period · Bookkeeping · Cash and accrual basis · Cash flow management · … Wikipedia

Discounted cash flow — Excel spreadsheet uses Free cash flows to estimate stock s Fair Value and measure the sensibility of WACC and Perpetual growth In finance, discounted cash flow (DCF) analysis is a method of valuing a project, company, or asset using the concepts… … Wikipedia

discounted cash flow — DCF A method used in capital budgeting, capital expenditure appraisal, and decision appraisal that predicts the stream of cash flows, both inflows and outflows, over time and discounts them, using a cost of capital or hurdle rate, to present… … Accounting dictionary

discounted cash flow — DCF A method used in capital budgeting, capital expenditure appraisal, and decision appraisal that predicts the future stream of cash flows, both inflows and outflows, over time and discounts them, using a cost of capital rate or hurdle rate, to… … Big dictionary of business and management

Matching principle — Accountancy Key concepts Accountant · Accounting period · Bookkeeping · Cash and accrual basis · Cash flow management · Chart of accounts  … Wikipedia

Comparison of cash and accrual methods of accounting — Accountancy Key concepts Accountant · Accounting period · Bookkeeping · Cash and accrual basis · Cash flow management · Chart of accounts  … Wikipedia

Принцип денежного потока — принцип оценки инвестиций, согласно которому существенным является лишь реальное движение денежных средств и его следует отражать в тот момент, когда оно происходит. По английски: Cash flow principle См. также: Инвестиционные решения Финансовый… … Финансовый словарь

ECONOMIC AFFAIRS — THE PRE MANDATE (LATE OTTOMAN) PERIOD Geography and Borders In September 1923 a new political entity was formally recognized by the international community. Palestine, or Ereẓ Israel as Jews have continued to refer to it for 2,000 years,… … Encyclopedia of Judaism

Economic Affairs — ▪ 2006 Introduction In 2005 rising U.S. deficits, tight monetary policies, and higher oil prices triggered by hurricane damage in the Gulf of Mexico were moderating influences on the world economy and on U.S. stock markets, but some other… … Universalium

П — Пааше индекс [Paasche price index] Пагамент (Payment in cash) Пай (share, stock, stake) Пакет акций (interest, stock ) Пакетный множитель (blockage factor) … Экономико-математический словарь

accounting — /euh kown ting/, n. 1. the theory and system of setting up, maintaining, and auditing the books of a firm; art of analyzing the financial position and operating results of a business house from a study of its sales, purchases, overhead, etc.… … Universalium

How to apply cash flow principles to your financial life

Free Cash Flows • Interested in after-tax cash flows, not profits. Why? • Interested in incremental cash flows. – – Do not count if take cash from existing products/services Can count synergistic effects of a new project Include incremental expenses “Sunk costs are sunk” • Interested in free cash flows – Cash generated by operations – Cash available to pay creditors or owners • Separate the investment decision from the financing – How is the cost of financing already incorporated?

How to apply cash flow principles to your financial life

Free Cash Flow Initial Outlay • Initial outlay – – Initial start-up costs Increases in working capital Sale prices of any replaced assets Capital gains taxes due to sale above/below depreciated value initial outlay = cost of new assets – sale price of replaced assets +/- tax impact of sale of replaced assets

How to apply cash flow principles to your financial life

Free Cash Flow Annual and Terminal Flows • Annually – Look at cash from operations – Adjust for • Depreciation impact on taxes – Depreciation is not cash but is a cost and lowers taxes • Interest expenses • Changes in net working capital – E. g. if have greater accounts receivable or inventory or payables • When project ends – Calculate terminal (final) value of assets

How to apply cash flow principles to your financial life

Projects in Practice • Projects may end up being delayed – Due to economic reasons – Due to political reasons – Due to technological reasons • Projects may be expanded • Projects may be canceled – Due to economic reasons – Due to political reasons – Due to technological reasons

How to apply cash flow principles to your financial life

Project Risk • Stand alone risk – All projects have risk, uncertainty • Contribution-to-firm risk – Project add risk to firm – Project risk can be diversified with other projects • Systematic risk – From viewpoint of shareholder – A project risk can be diversified by other shareholder investments • Text says that theoretically only systematic risk is important – Not from the viewpoint of the firm! – Not from the viewpoint of a project manager!

How to apply cash flow principles to your financial life

Risk and Capital Budgeting • Incorporate risk into discount rate – Increase hurdle rate to account for risk – Greater risk requires greater return • Can try to calculate systematic risk – Calculate a beta for the project – But there are no historical returns – Two approaches: 1. Can try comparing past division results to benchmark (accounting method) 2. Pure play method – use the beta of a firm that looks like the project

How to apply cash flow principles to your financial life

Use Simulations to Evaluate Risk • Have multiple factors that all have risk and a range of outcomes – Market size – Market share – Costs • Evaluate a scenario – Select values for each factor and compute a result – Get an IRR or NPV • Evaluate many (thousands) of scenarios – Get a distribution of outcomes for IRR or NPV – Can get a “probability” distribution for IRR or NPV

Cash flow — For other uses, see Cash flow (disambiguation). Accountancy Key concepts Accountant · Accounting period · Bookkeeping · Cash and accrual basis · Cash flow management · … Wikipedia

Discounted cash flow — Excel spreadsheet uses Free cash flows to estimate stock s Fair Value and measure the sensibility of WACC and Perpetual growth In finance, discounted cash flow (DCF) analysis is a method of valuing a project, company, or asset using the concepts… … Wikipedia

discounted cash flow — DCF A method used in capital budgeting, capital expenditure appraisal, and decision appraisal that predicts the stream of cash flows, both inflows and outflows, over time and discounts them, using a cost of capital or hurdle rate, to present… … Accounting dictionary

discounted cash flow — DCF A method used in capital budgeting, capital expenditure appraisal, and decision appraisal that predicts the future stream of cash flows, both inflows and outflows, over time and discounts them, using a cost of capital rate or hurdle rate, to… … Big dictionary of business and management

Matching principle — Accountancy Key concepts Accountant · Accounting period · Bookkeeping · Cash and accrual basis · Cash flow management · Chart of accounts  … Wikipedia

Comparison of cash and accrual methods of accounting — Accountancy Key concepts Accountant · Accounting period · Bookkeeping · Cash and accrual basis · Cash flow management · Chart of accounts  … Wikipedia

Принцип денежного потока — принцип оценки инвестиций, согласно которому существенным является лишь реальное движение денежных средств и его следует отражать в тот момент, когда оно происходит. По английски: Cash flow principle См. также: Инвестиционные решения Финансовый… … Финансовый словарь

ECONOMIC AFFAIRS — THE PRE MANDATE (LATE OTTOMAN) PERIOD Geography and Borders In September 1923 a new political entity was formally recognized by the international community. Palestine, or Ereẓ Israel as Jews have continued to refer to it for 2,000 years,… … Encyclopedia of Judaism

Economic Affairs — ▪ 2006 Introduction In 2005 rising U.S. deficits, tight monetary policies, and higher oil prices triggered by hurricane damage in the Gulf of Mexico were moderating influences on the world economy and on U.S. stock markets, but some other… … Universalium

П — Пааше индекс [Paasche price index] Пагамент (Payment in cash) Пай (share, stock, stake) Пакет акций (interest, stock ) Пакетный множитель (blockage factor) … Экономико-математический словарь

accounting — /euh kown ting/, n. 1. the theory and system of setting up, maintaining, and auditing the books of a firm; art of analyzing the financial position and operating results of a business house from a study of its sales, purchases, overhead, etc.… … Universalium

It’s essential for any business to have basic accounting principles in mind to ensure the most accurate financial position. Your clients and stakeholders maintain trust within your company so recording reliable and certified information is key. What are the 5 basic principles of accounting? To better understand the principles, let’s take a look at what they are.

1. Revenue Recognition Principle

When you are recording information about your business, you need to consider the revenue recognition principle. This is the period of time where revenues are recognized through the income statement of your company. In order for your revenues to be recognized in the period that the services were provided if you are on the accrual basis, If you are on the cash basis then, the revenues need to be recognized in the period the cash was received.

2. Cost Principle

Recording your assets when you purchase a product or service helps keep your business’s expenses orderly. It’s important to record the acquisition price of anything you spend money on and properly record depreciation for those assets.

3. Matching Principle

Expenses should be matched to the revenues recognized in the same accounting period and be recorded in the period the expense was incurred. If there is a period of time where revenue was recognized on sold products or services, then the cost of those things should also be recognized..

4. Full Disclosure Principle

The information on financial statements should be complete so that nothing is misleading. With this intention, important partners or clients will be aware of relevant information concerning your company.

5. Objectivity Principle

The accounting data should consistently stay accurate and be free of personal opinions. Make sure the data is also supported by evidence that can include vouchers, receipts, and invoices. Having an objective viewpoint, in this case, helps rely on financial results. For example, your viewpoint may not be objective if you once worked for the same company that you are now an auditor for because your relationship with this client might skew your work.

Now that you’ve got all of these down, moving forward with the financial positioning of your business will be effortless.

Contact us at 877-232-6788 if you have any questions or concerns about implementing these basic accounting principles to your business.

Conducting a cash flow analysis may help give you a more accurate understanding of your company's cash flow and performance.

Do you have a successful business? How do you know? Since success can be defined in so many ways, it’s important to have a standard, universally accepted measure of success in business. That universal measure is cash. How much cash a business has on hand, how much cash a business generates over a given period of time and how much cash someone would pay to buy your business are all ways to quantify the success of a business in a common unit of measure. For this reason, it may be beneficial for small-business owners to know how much cash is received and spent over time and plan to ensure that it has sufficient cash to manage its operations and fund its growth. One way to do this is through cash flow analysis.

Why Cash Flow Analysis?

Cash flow analysis measures how much cash is generated and spent by a business during a given period of time. I think it is the best measure of a company’s performance because:

It can be measured and compared. Cash is tangible, quantifiable and can be measured in standard units acceptable to anyone. When comparing two companies—no matter how different—cash flow is a vehicle for preparing a true “apples to apples” comparison.

It’s difficult to fake. There are many unscrupulous techniques that can be used to inflate profits, to artificially increase the value of assets or to otherwise temporarily make a business look more successful than it really is. It’s difficult though to do the same with cash.

It’s universally accepted as a store of value. You don’t have to convince anyone as to the value of $10 million in cash. The same cannot be said for other assets like intellectual property, good will, depreciated equipment and more. A used forklift may be worth something to the owner of a warehouse but it’s worthless to a writer. An idea may be valuable to some people and useless to others. Everyone accepts cash.

The Importance of the Cash Flow Statement

The cash flow statement is the financial statement that presents the cash inflows and outflows of a business during a given period of time. It is equally as important as the income statement and balance sheet for cash flow analysis. Without a cash flow statement, it may be difficult to have an accurate picture of a company’s performance. The income statement will tell you how much interest you paid on a loan and the balance sheet will tell you how much you owe, but only the cash flow statement will tell you how much cash was consumed servicing that loan. The income statement will record sales and profits but it’s the cash flow statement that will alert you if those sales aren’t generating enough cash to cover expenses.

There are two generally accepted formats for the cash flow statement: the direct method and the indirect method. In both cases, cash flows from three main areas.

Operations

Cash flow from operations represents the main type of cash inflow and outflow for a business. Cash comes in from customers and goes out to pay for expenses, including inventory. When thinking about cash inflows from operations, it may be helpful to remember that it is not a measure of revenues. A company could sell $1 million this month and that sale could generate zero in cash if the entire amount is sold on 60-day credit terms. The income statement will show the revenues and the balance sheet will show an increase in accounts receivables, but there won’t be any incoming cash from this activity. Since your business will need to spend cash now to fulfill the order, it’s important to ensure that you have sufficient cash—or access to cash—in order to avoid a cash crunch.

Investment Activities

Cash flow from investment activities represents cash flows mainly from the purchase or sale of fixed assets. It also includes other less common investment-related activities, but its main focus is plant, property and equipment. Cash from these activities is separate from operations because they tend to be for long-term planning and are not directly related to the day-to-day cash operations of a business. A company that consumes large amounts of cash for investment purposes indicates that it is investing for future growth, which consumes cash. If the cash from operations isn’t enough to cover investment activities, then another type of cash flow may be helpful.

Financing Activities

Cash flow from financing activities represents cash flows to and from third-party financial backers. It consists of cash related to debt such as proceeds (cash in) and loan payments (cash out). It also covers cash flow related to equity, such as share purchases (cash in) and dividends (cash out). Cash flow from financing activities helps gauge how much cash the company is generating on a net basis from third parties as opposed to cash from ongoing operations.

Do you have an accurate picture of your company’s cash flow? Do you prepare periodic cash flow statements and cash flow analysis? Let me know in the comments below.

Generally Accepted Accounting Principles or GAAP are the set of accounting principles, concepts, and guidelines that guide the more detailed and comprehensive accounting rules, practices, and standards. There are ten major GAAP principles that have evolved over decades and serve as the foundation of accounting. In the US, every company releases its financial statements to the public. And, companies that publicly trade on stock exchanges need to follow GAAP guidelines.

Origin of GAAP Principles

The origin of GAAP goes way back to 1929 and the stock market crash that led to the Great Depression. At the time, faith in the economy was at an all-time low. Thus, the government decided to rebuild the faith and the Securities and Exchange Commission (SEC) was formed. The SEC asked the American Institute of Accountants for help and this gave rise to the concept of GAAP.

Over time, many changes have been made to these accounting standards. Also, the governing boards have changed. Presently, the Financial Accounts Standard Board (FASB) decides the accounting principles under GAAP, but the Securities and Exchange Commission (SEC) still has enforcement powers. To know more about the differences between generally accepted accounting standards and accounting principles, refer to GAAS vs GAAP

GAAP covers a range of topics, such as revenue and expenses, assets and liabilities, financial statement presentation, equities, foreign currency, hedging, business combinations, derivatives, and non-monetary transactions. To understand GAAP, it is important to understand the ten GAAP principles.

10 GAAP Principles

Discussed below are ten major GAAP principles;

Single Entity Principle

The business as a single entity concept states that all financial records of the business should be separate from the owners or other businesses. A company must report the assets and liabilities of different subsidiaries separately and not mix them with the books of another company. In the absence of this principle, the records of multiple entities would get mixed, making it unfeasible from the point of view of financial audit or tax purposes.

Monetary Unit Principle

There should be a specific unit of currency in which the company should record transactions. All the transactions in the financial statements should be in the same currency unit, be it the US dollar, Euro, Indian Rupee, or any other currency. It would be wrong to record some transactions in one currency and some in another currency.

Specific Time Period Principle

Financial statements are always related to a specific time, usually towards the end of the financial accounting period. All three financial statements – Income, Balance Sheet, and Cash Flow Statement have a start, as well as, the end date. The purpose is to ensure that stakeholders are aware of the time period for which the company is reporting numbers.

Recognition Principle

This principle, as the name suggests, states that a company should record both revenue and expenses when earned and not when it gets the cash. Therefore, the income statement of the company includes accrued income and expenses. In case there is any doubt on the suppliers regarding the payment, the accountant should put the item under the allowance for doubtful accounts.

Going Concern Principle

As clear from the name, everyone expects a business to run eternally with no end date. It also means that the business must not cease operations and liquidate the assets in the near future at very low fire-sale prices. Because of this principle, a company can defer certain expenses to a future date.

If an accountant believes that the company might no longer be a going concern, the accountant must detail the same in his or her assessment. In case of liquidation, the accountant must write down the value of the assets to their liquidation value. A point to note is that the value of a going concern firm is perceived to be higher than the liquidation value. This is because, in the former, there are chances that the company would turn profitable.

How to apply cash flow principles to your financial life

Full Disclosure Principle

Every company must make full disclosure and ensure that all the details and financial numbers are open to the public. This principle ensures that companies do not hide any material information, which can impact the investment decision of the stakeholders. Also, this principle ensures that the companies do not indulge in any unethical operations and businesses. And, no financial information that should be in the public domain is hidden intentionally.

Matching Principle

It is one of the most basic principles. And, requires a company to report an expense in the period in which it earns the corresponding revenue. The matching principle depends on the accrual basis of accounting and adjusting entries. In case, an expense does not directly relate to the revenue, report it on the income statement when it expires or after using it. And, if the future benefit of a cost cannot be determined, it should be charged to the expense immediately.

Principle of Materiality

As per this GAAP principle, it is important for the bookkeeper to think materialistically. An accountant should be able to differentiate between the important and not so important issues. Errors are inevitable in accounting. However, it is up to the bookkeeper to decide on whether the error is important enough to give more time to it, or can be ignored. For example, it is up to the accountant whether to ignore a $10 error or not.

Principle of Conservative Accounting

The principle suggests that an accountant must record expenses as and when they occur. On the other hand, the accountant should only record income when there is actual cash flow. This principle helps while recording transactions that are uncertain.

Historical Cost Principle

As per this principle, a company should record the purchase of the goods, services, or capital assets at the price they actually paid for it. On the balance sheet, companies keep showing the asset at the historical without adjusting for any fluctuation in the market value.

Final Words

Though the objective of these GAAP principles is to improve transparency, there is no guarantee that the financial statements of the companies following these principles are free from errors and omissions (both intentional and unintentional). There have been plenty of cases where companies following GAAP distort figures to mislead investors. So even if a company follows GAAP, it is always better to scrutinize its financial statements. 1

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accounting — /euh kown ting/, n. 1. the theory and system of setting up, maintaining, and auditing the books of a firm; art of analyzing the financial position and operating results of a business house from a study of its sales, purchases, overhead, etc.… … Universalium

The definition of cash flow management for business can be summarized as the process of monitoring, analyzing, and optimizing the net amount of cash receipts minus cash expenses. Net cash flow is an important measure of financial health for any business.

Importance of Cash Flow Management

According to a study performed by Jessie Hagen of U.S. Bank, 82 percent of businesses fail because of poor management of cash flow. If your business constantly spends more than it earns, you have a cash flow problem.

For small businesses, the most important aspect of cash flow management is avoiding extended cash shortages, caused by an overly large gap between cash inflows and outflows. You won’t be able to stay in business if you can’t pay your bills for an extended period of time.

Examples of Cash Flow Management Problems in Business

Real estate development has always been a highly cyclical industry, and developers are often prone to cash flow problems. Property development requires significant initial capital investment, as well as ongoing cash outflows for operations.

Unless some or all of the development can be sold before construction, developers often run into cash flow problems before the development begins to sell off, particularly if the property market happens to soften during construction. Many property developers have been forced into bankruptcy because of negative cash flow for extended periods of time.

Any business that’s undergoing rapid expansion can run into cash flow problems as well. Business expansion generally involves higher labor costs as new employees are hired, higher rent for additional space, higher advertising costs, and more capital investment for new facilities, equipment, and so on. Having to maintain increased levels of inventory can also eat into excess cash.

Extending credit to other businesses is another common way for businesses to run into cash flow problems. Invoicing is normally done on 30- or 60-day terms, and it isn’t unusual for customers to delay payment, which can leave a business in a cash flow crunch. An example of a business with cash flow management problems and a negative cash balance for the year is:

Acme, Inc. – Cash Flow Statement for the Year Ended Dec. 31, 2018

Cash Flow From Operations $
Receipts
Customer Invoices $80,500
Other $1,500
Disbursements
Employee Salaries -$45,000
Suppliers -$25,500
Other -$5,000
Net Cash Flow From Operations $6,500
Cash Flow From Investments
Equipment and Software Purchases -$5,500
Net Cash Flow From Investments -$5,500
Cash Flow From Financing
Loan Payments -$3,300
Shareholder Dividends -$5,000
Net Cash Flow From Financing -$8,300
Net Change in Cash Balance -$7,300

Solving Cash Flow Problems

As a business owner, you need to perform a cash flow analysis on a regular basis and use cash flow forecasting so you can take the steps necessary to head off cash flow problems. Many software accounting programs have built-in reporting features that make cash flow analysis easy. This is the first step in cash flow management.

The second step of cash flow management is to develop and use strategies that will maintain adequate cash flow for your business. One of the most useful strategies for your small business is to shorten the cash flow conversion period so that your business can bring in money faster.

If your business is expanding, you may need one or more injections of cash during the growth phase. This can take the form of a business loan from a financial institution known as debt financing or equity financing from investors.

Debt Financing vs. Equity Financing

Debt financing is common for assets, such as equipment, buildings, land, or machinery, when the assets to be purchased are used as security or collateral for the loan. The main advantage of debt financing over equity financing is that the business owner doesn’t have to give up partial ownership of the business and thus can retain full control. For short-term cash flow shortages, many small business owners make use of credit cards or lines of credit.

Equity financing involves raising money from angel investors or venture capitalists. Equity financing is much less risky because money invested doesn’t have to be repaid if the business doesn’t succeed. However, in exchange for financing, the investor becomes a part owner and, as such, takes a share of the profits and has a say in how the business is run.

Whatever form of financing is required, it’s vital to have an updated business plan in place to present to financial institutions or investors. The business plan should demonstrate the need (and effect) of financing for the future of the business.

How to apply cash flow principles to your financial life

As someone with responsibilities across the whole organization, you may not feel like you have time to dig through your business’s financial data every day. If you’re lucky, you may have a chief financial officer or a chief operating officer who manages the company’s finances.

However, many companies don’t, and most entrepreneurs can benefit from taking a more hands-on approach to understanding the financial health of their business. You might be surprised at the amount of valuable insight that can be gained from having a firm understanding of your company’s financial statements.

If you’re looking to get a full picture of your business’ financial performance, it’s prudent to study all three of your company’s financial statements: The income statement, the balance sheet and the cash flow statement.

The income statement shows the sales and profitability of your business for a specific period of time, while the balance sheet gives you a snapshot of your overall financial condition at a point in time. The cash flow statement, meanwhile, blends the balance sheet and income statement together in order to display how cash has come into and gone out of your business.

While the cash flow statement is often neglected, it shouldn’t be, given the importance of cash to your business. As Karen Berman and Joe Knight explain in their book, “Financial Intelligence for Entrepreneurs,” you should think of the cash flow statement as a proxy for a company’s bank account, i.e. debits and credits.

Why cash flow matters

One of the reasons the cash flow statement is so helpful is that many companies record transactions when they occur, even if no cash has changed hands yet (called the accrual method of accounting) because of credit arrangements or other factors. As a result, your business may have strong sales and net income as shown on the income statement, but you could be burning through cash quickly.

“In my experience, it’s not lack of profitability or lack of revenue that leads to business failure,” says Sageworks chairman Brian Hamilton. “Cash flow is the real killer.”

Famed investor Warren Buffett uses information in the cash flow statement to determine whether a company has a “durable competitive advantage.” Just as Buffett uses the cash flow statement to gain insight about potential investments, you can use it as a means to a kind of self-examination. It’s not necessarily going to be pretty, but an honest assessment of your financial health through the use of the cash flow statement can reveal serious red flags in your business. It might even save it.

How to read it

The cash flow statement is divided into segments in order to outline cash flows from three major activities of all companies: operations, investing and financing.

The information on cash flows from operating activities is really the most critical, Hamilton says, because it shows how much money you are generating from regular operations – from the basic, fundamental production and sales of goods and/or services.

It starts with the net income reported on the income statement, then adds back non-cash expenses (such as depreciation and provisions the company made for doubtful accounts) and adjusts for changes to current assets and current liabilities. For example, a sale made on credit does not affect cash, but it would increase sales (and therefore net income) and would create an increase in accounts receivable. The related increase in accounts receivable is deducted from net income to show the actual cash from operations.

“That number is crucial, because if you compare that to profitability, now you know two things,” Hamilton says. “Are you profitable by GAAP? And are you actually making cash through your operations?”

Looking past the net increase/decrease line

It’s easy to simply look at net increase or decrease in cash for the period, but if you do that, you’ll miss other important information. Knowing how you’re getting and spending your cash allows you to better gauge the quality of your earnings – that is, are they actually sustainable or aided by external factors?

For example, the section on cash flows from financing activities may show that equity was issued to raise cash or to make acquisitions. While raising cash through equity may be a good thing, it’s not money that your business has generated on its own, and your business may not survive long if it doesn’t generate cash on its own. This section on financing will also show whether stock issuances are outpacing or lagging stock repurchases, an issue of keen interest to your shareholders.

A 10,000 foot view

The section on cash flows from investing activities provides a 10,000 foot view perspective: Are you currently investing cash in the future growth of the business through new facilities or other capital expenditures? Are you selling assets to bring in more cash? Are you allocating cash in an entirely different way than peers? Hopefully you already have the answers to these questions, and that the answers are in line with your overall strategic goals as a company. However as your company begins or continues to grow, it cannot hurt to keep a close eye on this 10,000 foot view that the statement of cash flows can provide.

Finally, metrics and ratios based on information contained in the cash flow statement can give you a clear indication of your liquidity, your ability to operate as a going concern and your long-term value. These ratios include the cash interest coverage ratio and the cash current debt coverage ratio. One metric that gets a lot of attention is free cash flow, which is calculated by subtracting capital expenditures from net cash from operations.

This will be an especially important metric to keep your eye on if you’re thinking of going public at some point, as it is the major component used to evaluate pricing for initial public offerings.

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How to apply cash flow principles to your financial life

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How to apply cash flow principles to your financial life

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Since our Explanation of Cash Flow Statement illustrates how the amounts are determined, you will get a better understanding of this very important financial statement. No longer will you look at only the income statement and balance sheet.

This 33-question quiz is a fast way to assess your understanding of the Cash Flow Statement Explanation. It’s also a great warmup for our Quick Test.

Our visual tutorial for the topic Cash Flow Statement gives you a step-by-step presentation to help you understand and appreciate the wealth of information contained in the cash flow statement. Distinguish yourself from others and learn the importance of this financial statement. Many believe that cash is king!

Our financial statements videos will help you learn and review the balance sheet, income statement, and statement of cash flows. This video training consists of 14 videos of approximately 10 minutes each.

We’ve answered 45 popular questions related to the topic Cash Flow Statement. Review them all or use the search box found at the top of each page of our website for your specific questions.

Our flashcards for the topic Cash Flow Statement will help you master key terms and definitions. You can view them on any device or print them out.

If you find Cash Flow Statement terminology difficult, this Word Scramble will provide clues (scrambled answers) to assist you.

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We created this crossword puzzle for you to learn, review, and retain terminology for the topic Cash Flow Statement in a more fun format.

We created this crossword puzzle for you to learn, review, and retain terminology for the topic Cash Flow Statement in a more fun format.

Our two cash flow statement forms will guide you in getting the positive and negative amounts presented properly. All of our business forms contain an Excel template, a blank PDF form, and a filled-in PDF form.

This Cash Flow Statement Cheat Sheet will help you to understand the positive and negative amounts presented on the Cash Flow Statement.

This graded 40-question test measures your understanding of the topic Cash Flow Statement. Discover which concepts you need to study further and enhance your long-term retention. All of our quick tests can be taken online and/or printed.

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As you study for this certificate exam, you will be taking your financial literacy to higher level. No longer will you ignore this valuable, required, and insightful financial statement. Not only will you better understand where a company’s cash has been going, you will also discover indicators of potential operational problems within a company.

How to apply cash flow principles to your financial life

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Or maybe you’re wanting your business to grow and you’re looking for investment options. Taking on debt is a very common and relatively cheap way of solving some of these problems.

If your business has been impacted by the COVID-19 pandemic, you may be eligible to apply for government-backed loan schemes such as the Recovery Loan Scheme in the UK.

How can a cash flow forecast help my loan application?

Cash flow, the movement of money coming in and out of your business, tells a lender a whole load of information about your business. It gives them an idea of how much will be left over after you’ve paid all of your daily expenses, which is also called your ‘net cash flow’. Your net cash flow is one indicator that signals whether your business is struggling, breaking even or hitting it out of the park.

No matter what kind of lending you’re looking for, it’s likely a cash flow forecast will be an important part of your application. Before you run away with it, we recommend checking that your lender allows the submission of a cash flow forecast as part of your application.

How to use a forecast to apply for your loan

1. Start with an accurate forecast

Make sure you create a cash flow forecast that’s realistic. If you’re using Float already, we recommend using your base forecast for this. In this ‘most likely’ situation, include projections you’re fairly sure will happen. Think about what your future bank balance could look like. What’s going to come in and when? Is your business seasonal? Are there any large upcoming one-offs? No matter what it’s for, if you’re expecting cash in or out, it should be included in your forecast. If you’ve never done cash flow forecasting before and you’re not sure where to start, have a look at what happened last year or in the last few months and take these into account when creating your forecast.

Update these figures every time your expectations change so that you’re never running completely blindfolded. This can be a difficult exercise and it’s all estimates and projections but the closer it gets to today’s date, the more accurate it should be. If there are other people in your organisation that know different bits of key information, involve them in the process.

2. Work out how much you need

Then, include the amount of debt you’re hoping to take on. If you’re using Float already, add a scenario layer for this using the scenario planning tool. This should quickly tell you and the lender whether what you’re asking for is the right amount and that your business can afford it. If it looks like you’re still running at a negative net cash position despite the extra loan income, you may have to rethink your application or consider different funding options. Remember to include potential, realistic interest and capital repayments as cash-outflows in the same scenario!

3. Create multiple forecasts

The lender wants to know what your ‘best case’ scenario could look like and, arguably more important, what your ‘worst case’ scenario could be. The lender will probably be much more interested in the worst case scenario, as they are constantly considering risk. If your forecasts are conservative and clearly take into account everything that could possibly go wrong and you can still prove that your business will be able to repay the loan, this could really help your application.

If your forecast shows that you’re expecting to have a ‘positive’ net cash position, it indicates that your business could successfully handle taking on debt. Positive net cash flow also gives the lender an indication that your business is growing, as you’ve got spare cash to reinvest into your business. In this situation, preparing a cash flow forecast may help you negotiate more favourable lending terms.

In Float you can export your cash flow forecast to a PDF to attach to your loan application. This will give your potential lender a clear, concise view of your cash projections that’s easy to understand at a glance. Here’s a quick video on how to get that download in Float…

How to apply cash flow principles to your financial life

Regardless of what cash position you’re currently sitting at, a cash flow forecast can indicate to a lender that you’re prepared, in control and, most importantly, can repay everything you’ll owe.

Create your own cash flow forecast in Float today, with a 14-day free trial.

Cash Flow with Benefits assists clients with building a personal banking system based on Nelson Nash’s Infinite Banking Concept. By taking control of the financial equation you can gain financial independence.

How to apply cash flow principles to your financial life

Dec 8 First Principle: You Finance Everything

The first principle to understand when learning how IBC operates is that everything a person buys is financed, either by borrowing from a lender or by using your own money, thereby foregoing the interest you would have otherwise received on the funds. This concept is also known as the opportunity cost of money.

EVA: Economic Value Added

In this regard, Nash mentions economic value added (EVA), which refers to the earnings on a sum of capital above and beyond the cost of that capital.

In the case of Economic Value Added, EVA, Nash reports that many large corporations produced tremendous success by adopting EVA, which centers on the idea that use of your own funds has a cost of capital. By removing the need to pay interest to others and directing that same amount of interest to a life insurance policy under your control which features tax-deferred growth, he says, you can improve your financial situation. Like EVA, for this type of system to work, Nash states, “the Infinite Banking Concept must become a way of life. You must use it or lose it!”

Dividends

Life insurance is a product that has been around for over 200 years. In addition to the ability to earn tax-deferred interest, life insurance dividends generated by policies from participating life companies are also free from current taxation, as they are a form of return of principal.

Nash next discusses the idea that if you are paying out more than 35% of every dollar you make in after-tax income in interest, your need for finance is likely to be greater than your need for life insurance over the course of your working years. By using dividend-paying life insurance to address your life insurance needs, Nash claims that you will then automatically be able to build up more life insurance while regaining the totality of the interest you would otherwise be paying to someone else.

This program, however, almost never occurs, according to Nash, because of the bias against using life insurance as a place to store money. Thus, instead of paying the insurance company an amount which encompasses the funds needed to keep the insurance in force plus the sums needed to build up enough cash to finance a car payment and other financial needs, these funds are paid separately in the form of car payments, credit card payments, etc. You would be better off, Nash states, by paying these sums to the insurance company and cutting out the middleman.

The key, he believes, is that you should make sure you are paying into the insurance policy the same amount you would otherwise be paying to the car finance company, thereby earning what the finance company would have earned for your own benefit. Ideally, you will contribute even more than that amount to increase the amount of cash in the account that you can use for other purposes.

The Cash Flow Statement, or Statement of Cash Flows, summarizes a company’s inflow and outflow of cash, meaning where a business’s money came from (cash receipts) and where it went (cash paid). By “cash” we mean both physical currency and money in a checking account. The cash flow statement is a standard financial statement used along with the balance sheet and income statement. The statement usually breaks down the cash flow into three categories including Operating, Investing and Financing activities. A simplified and less formal statement might only show cash in and cash out along with the beginning and ending cash for each period.

To perform a cash flow analysis, you can compare the cash flow statement over multiple months or years. You can also use the cash flow analysis to prepare an estimate or plan for future cash flows (i.e. a cash flow budget). This is important because cash flow is about timing – making sure you have money on hand when you need it to pay expenses, buy inventory and other assets, and pay your employees.

A cash flow analysis is not the same as the business budget or profit and loss projection which are based on the Income Statement. However, for a small uncomplicated business operating mainly with cash instead of credit accounts, there may seem to be little difference.

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How to apply cash flow principles to your financial life

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This cash flow statement was designed for the small-business owner looking for an example of how to format a statement of cash flows. The categories can be customized to suit your company’s needs. If you don’t want to separate the “cash receipts from” and the “cash paid for” then you can just delete the rows containing those labels and reorder the cash flow item descriptions as needed.

The spreadsheet contains two worksheets for year-to-year and month-to-month cash flow analysis or cash flow projections.

Update 9/30/2021: You can now try the cash flow template in Spreadsheet.com which uses a set of categories based on common public stock financial statements.

Cash Flow Statement Essentials

Operating Activities

Operating activities make up the day-to-day business, like selling products, purchasing inventory, paying wages, and paying operating expenses. Perhaps the most important line of the cash flow statement is the Net Cash Flow from Operations. This section of the statement is associated with the Current Assets and Current Liabilities sections of the Balance Sheet, as well as the Revenue and Expenses section of the Income Statement.

Investing Activities

Investing activities include buying and selling assets like property and equipment, lending money to others and collecting the principal, and buying/selling investment securities. This section of the statement is associated with the Long-Term Assets section of the balance sheet.

Financing Activities

Financing activities include borrowing from creditors and repaying loans, issuing and repurchasing stock, and collecting money from owners/investors, and payment of cash dividends. This section of the statement is associated with the Long-Term Liabilities and Owners’/Stockholders’ Equity from the Balance Sheet.

I’m not going to try to explain how to prepare or analyze the cash flow statement other than to say that if you have the records of all the cash transactions, then the preparation can be done using the simple method of categorizing the receipts and payments into the three categories listed above. The indirect method can be used to create the statement of cash flows from the information in the balance sheet and income statement, but I’ll leave that explanation for the textbooks. For more information, see the references below.

An accounting principle is a general guideline to follow when recording and reporting financial transactions. There is a change in accounting principle when:

There are two or more accounting principles that apply to a particular situation, and you shift to the other principle; or

When the accounting principle that formerly applied to the situation is no longer generally accepted; or

The method of applying the principle is changed.

You should only change an accounting principle when doing so is required by the accounting framework being used (either GAAP or IFRS), or you can justify that it is preferable to use the new principle.

Direct Effects of a Change in Accounting Principle

A direct effect of a change in accounting principle is a recognized change in an asset or liability that is required in order to effect the change in principle. For example, if you change from the FIFO to the specific identification method of inventory valuation, the resulting change in the recorded inventory cost is a direct effect of a change in accounting principle.

Indirect Effects of a Change in Accounting Principle

An indirect effect of a change in accounting principle is a change in an entity’s current or future cash flows from a change in accounting principles that is being applied retrospectively. Retrospective application means that you are applying the change in principle to the financial results of previous periods, as if the new principle had always been in use.

How to Retrospectively Apply a Change in Accounting Principle

You are required to retrospectively apply a change in accounting principle to all prior periods, unless it is impracticable to do so. To complete a retrospective application, the following steps are required:

Include the cumulative effect of the change on periods prior to those presented in the carrying amounts of assets and liabilities as of the beginning of the first period in which you are presenting financial statements; and

Enter an offsetting amount in the beginning retained earnings balance of the first period in which you are presenting financial statements; and

Adjust all presented financial statements to reflect the change to the new accounting principle.

These retrospective changes are only for the direct effects of the change in principle, including related income tax effects. You do not have to retrospectively adjust financial results for indirect effects.

When Not to Retrospectively Apply a Change in Accounting Principle

It is only impracticable to retrospectively apply the effects of a change in principle under one of the following circumstances:

You make all reasonable efforts to do so, but cannot complete the retrospective application

Doing so requires knowledge of management’s intent in a prior period, which you cannot substantiate

Doing so requires significant estimates, and it is impossible to create those estimates based on information available when the financial statements were originally issued

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How to apply cash flow principles to your financial life

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Milestone 1 Get a Financial Education

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After you’ve read the book, proper protection of your income should be the next Milestone to complete.

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How to apply cash flow principles to your financial life

Milestone 3 Create an Emergency Fund

Think about the three little pigs. One was ready for the unexpected. Two weren’t.

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Milestone 5 Increase Cash Flow

Cash flow is the money you have available to spend or to save.

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HowMoneyWorks® is on a mission to eradicate financial illiteracy—the #1 economic crisis in the world, which impacts more than 5 billion people across the planet. As a HowMoneyWorks Educator, my goal is to help you break the cycle of endless debt, foolish spending, and financial cluelessness so you can stop being a sucker, start being a student, and take control of your financial future.

Cash flow from assets is the aggregate total of all cash flows related to the assets of a business. This information is used to determine the net amount of cash being spun off by or used in the operations of a business. The concept is comprised of the following three types of cash flows:

Cash flow generated by operations. This is net income plus all non-cash expenses, which usually include depreciation and amortization.

Changes in working capital. This is the net change in accounts receivable, accounts payable, and inventory during the measurement period. An increase in working capital uses cash, while a decrease produces cash.

Changes in fixed assets. This is the net change in fixed assets before the effects of depreciation.

This measurement does not account for any financing sources, such as the use of debt or stock sales to offset any negative cash flow from assets.

Example of Cash Flow from Assets

A business earns $10,000 during the measurement period, and reports $2,000 of depreciation. It also experiences an increase of $30,000 of accounts receivable and an increase of $10,000 in inventory, versus an increase of $15,000 in accounts payable. The business spends $10,000 to acquire new fixed assets during the period. This results in the following cash flow from assets calculation:

+$12,000 = Cash flow generated by operations ($10,000 earnings + $2,000 depreciation)

-$25,000 = Change in working capital (+$15,000 payables – $30,000 receivables – $10,000 inventory)

-$10,000 = Fixed assets (-$10,000 fixed asset purchases)

-$23,000 = Cash flow from assets

How to Create Positive Cash Flow

Management can generate positive cash flow from assets by using a variety of techniques, including the following:

How to apply cash flow principles to your financial life

Accounting is one of the fundamental activities of any business. Without it, a company would be similar to a blind person driving a high-speed car. They may know how to do business, but they would be blind to important signals that Accounting can give them.

However, it is not only businesses that need Accounting for them to survive. Unbeknownst to many, even regular people like us are using it every single day. We use accounting to check our finances, manage our bills, and even for something as simple as buying groceries.

Surprised? Well, this simple explanation by Investopedia of what Accounting is may help you grasp the idea:

“Accounting is the systematic and comprehensive recording of financial transactions pertaining to a business, and it also refers to the process of summarizing, analyzing and reporting these transactions to oversight agencies and tax collection entities.”

-Investopedia

Although it is specifically about businesses, by reading it, you should a hint on how it applies to our lives. Let us try to use this definition of Accounting on something we often do in our personal lives, namely groceries.

How We Use Accounting Everyday

When cooking something at home, the first thing we often do is check if we have any supplies left. If not, the next thing we’d do is list down all the items that we will purchase in the store.
After you get all the things you need, you proceed to the cashier to pay them the total price of your groceries.

Finally, you rigorously count your change to make sure that there is no overage or shortage. If you find any, you are most likely going to approach the sales person to correct the error.

We’re you able to identify which parts were actions you did were related to accounting? If yes, then good job! But if not, then here’s a simple explanation on how groceries is related to accounting. Summarizing; by looking at your refrigerator, you were already summarizing which items you will buy and which ones you will not.

Analyzing; the act of counting your change to know whether they gave you too much or too little is like an accountant investigating if their business is receiving the correct amount of cash or revenue (auditing).

Reporting; lastly, reporting is when you try to communicate your data to other parties. Hence, when you explained to the cashier that she gave you too much or too little change, you are reporting to her based on how you analyzed what you previously summarized.

With every choice we make, whether for major or minor decision, we are unconsciously using the principles of accounting. Hence, it is an inescapable part of everybody’s lives. Nevertheless, there are also other ways that you could apply accounting to make your life better or earn/save some more of that sweet, sweet money.

Other Ways You Can Apply Accounting In Life

Budgeting Your Money

Most companies hire accountants at the beginning of every business cycle to help them determine the best way for them to spend their existing assets. The reason for budgeting is that it would assist them to avoid wasting their money or resources due to poor planning.

Private people can use the budgeting principles in accounting to help them allocate their salaries. Furthermore, it could help them avoid unexpected shortages due to overspending. Budgeting our expenses are not just limited to long term things like education, or retirement, but also to things that you engage daily like your fare or meals.

Tracking Your Expense And Income

After we budget our expenses, it is important that we know how to follow through it by tracking how we spend our money. Tracking is more of a continuous action that we need to do every time money leaves or enters our pockets.

By tracking our expenses, we can adjust our budget accordingly to accommodate new plans or information that was not available when we first budgeted our money.

Saving For The Future

The best case scenario after budgeting and tracking your expenses is having some leftover money that you can save. Savings are the result of well-planned budgets and careful tracking of expenditures. It allows you have some leeway for next month for emergencies and unexpected expenses.

Furthermore, by being able to save some money, you can be more assured that there is a smaller possibility of you having financial crises.

Investing To Make More Money

Lastly, if you were able to save enough money due to following the first parts of this section, the best move for you is to invest it let your money grow on itself.

You can invest your money in passive investing platforms like stocks, forex, bonds and more. You also have the choice to start up a business that you think would help you make more money than you already have.

There are many options for an individual to invest, all of which will need for you to apply more accounting. Lastly, it is also at this point that you’ll need to start considering asking for the help of professional accountants.

Regardless of how you use accounting in your life, the Aldaris CPA Group is here to help you grow your potential. Contact us for our individual and family consulting services and let us show you how we can help you with your personal finances.

How to apply cash flow principles to your financial life

Personal finance can be a complex subject, and it's easy to get overwhelmed with all the information that's out there. You could spend hours reading about how to handle money, with little to show for it after.

But money matters don't have to be so complicated. There are a few key principles that can make or break you, and if you want to build a strong financial future, then you need to know them by heart.

1. Spend less than you earn

This first principle is by far the most important. The only way you can be successful is by having more income than expenses every month.

By spending less than you earn, you can put money away for the future instead of living paycheck to paycheck or sinking deeper into debt because you can't pay your bills.

One popular piece of advice is that you should save at least 20% of your income in a high-quality bank account. That's a smart goal for most people, but if you can save even more, you absolutely should.

2. Maximize your income

Although it doesn't get talked about enough in the world of personal finance, increasing your income is the best way to save more money, rather than pinching pennies.

The amount you can save by reducing your spending is limited. Sure, you can make cuts here and there, but that doesn't work forever. Eventually, you'll reach the point where there are no more cuts left to make.

Instead of trying to budget your way to being rich, you're much better off looking for ways to make more money. Negotiating a raise, finding a higher-paying job, freelancing, or starting a business on the side are all ways you can bring more money in.

3. Plan for emergencies

Emergencies are a fact of life. If you're not ready for them, they can cost you a lot of money. There are two ways to prepare for emergency expenses:

  • Putting money into an emergency fund
  • Making sure you have all your necessary insurance coverages

Your emergency fund is the money you'll use for any unexpected bills that come your way. Ideally, you should have three to six months of living expenses in your emergency fund. It takes some time to save that much, but any money you save is better than nothing. Get your emergency fund started by opening a high-interest savings account and depositing whatever you can manage every month.

People often skimp on insurance, only to wish they hadn't when they get hit with a huge bill later. At a minimum, you should have:

  • Health insurance
  • Renter's or homeowner's insurance
  • Auto insurance

4. Build your credit

Like it or not, your credit score can have a significant impact on your everyday life. If you ever want to get one of the top credit cards or borrow money at a low interest rate, then your credit score will play a key role. That's not all it does, though: Your credit can also determine your car insurance rates, whether you pay a deposit when setting up utilities, and even whether you get hired for certain jobs.

The good news is that, despite the confusion about credit scores, it's not hard to build yours. You'll need a credit card that you use and pay off every month, as this helps you build a record of responsible borrowing. If you've had trouble qualifying for a credit card, secured credit cards are a good place to start.

Just make sure you're paying your bills by the due date and not using too much of your available credit. Those are the building blocks of an excellent credit score.

5. Save for retirement

Retirement, a.k.a. that thing most people start thinking about much later than they should. The sooner you start contributing to a retirement account, the better off you'll be.

It's imperative that you start saving for retirement early and take advantage of the tax breaks offered through 401(k)s and individual retirement accounts (IRAs). You'll give your money plenty of time to accumulate through compound interest, which is the smartest way to build wealth.

What's important here is that you save something every month for retirement. Whether it's $50, $100, or over $1,000, later on you'll appreciate that you got into the habit of saving. So long as you invest the money responsibly, your contributions will grow many times over throughout your career.

The only financial advice you need

It's not necessary to weigh yourself down with tons of financial tips. The personal finance principles described above can help you no matter what you do or where you are in life. Follow them religiously, and not only will you end up financially stable, but you'll also be able to grow your wealth for the future.

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