Cash Flow
Textbook Reference
P. 382-387
What is Cash Flow
• Cash Flow represents the changes in the cash
account over a period of time.
• Cash flows in through business operations,
financing or investment income.
• Cash flows out through expenses, donations,
drawings and investing.
• A business must ensure that cash inflows equal
or exceed cash outflows.
Solvency
• Solvency is the term used to describe having
adequate cash on hand. If a business is solvent,
it has enough cash to pay its employees,
suppliers and any expenses.
• If a business is insolvent, it is unable to meet
these obligations.
Solvency and Profitability
• Solvency is not the same thing as profitability.
• It is possible to be profitable and to be insolvent
at the same time.
• A profitable business, therefore, may end up
being a candidate for bankruptcy if it does not
properly manage its cash flow.
Example
• Pacific Packaging built a custom packaging
machine at a cost of $6000 and sold it for
$10,000 on 30-day terms.
• This means a debit to accounts receivable and a
credit to revenue. No cash has actually flowed.
• This machine will provide a profit of $4000,
BUT…….
Example
• The customer will not be paying for 30 days. In
the meantime, Pacific Packaging will need to pay
its expenses for building the machine and will
need to pay its employees.
• Pacific Packaging needs to make sure that it has
enough cash on hand to meet these obligations.
Otherwise, the suppliers can make a claim
against the assets and possibly force Pacific
Packaging into bankruptcy!
So what can be done?
• An income statement does not provide adequate
information about cash flow.
• Nor does the balance sheet, because it only
provides the bank balance at one period in time.
• A Statement of Cash Flow is required for a
company to avoid insolvency.
Statement of Cash Flow
• Records the changes to the cash account over
time.
• List all sources of cash over the period.
• List all uses of cash over the period.
• Subtract the uses from the sources. The
difference is added to the bank balance at the
beginning of the period.
Now its YOUR turn…
• Download the cash flow exercise from ClassNet.
• Complete the Statement of Cash Flow using MS
Excel.