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Review your income statement and balance sheet
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Categorize your cash flows correctly
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Use the indirect method for operating cash flows
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Reconcile your cash flows with your bank statements
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Use accounting software and tools
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Here’s what else to consider
A cash flow statement is a vital financial report that shows how much cash your business generates and uses during a specific period. It helps you assess your liquidity, solvency, and profitability. However, preparing an accurate cash flow statement can be challenging, especially if you have complex transactions, multiple sources of income and expenses, or accounting errors. In this article, you will learn some tips and best practices to ensure cash flow statement accuracy and avoid common mistakes.
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1 Review your income statement and balance sheet
Before you start working on your cash flow statement, you should review your income statement and balance sheet for the same period. These two statements provide the data and adjustments you need to calculate your cash flows from operating, investing, and financing activities. Make sure that your income statement and balance sheet are accurate, complete, and consistent with your accounting policies and standards. If you find any discrepancies, errors, or missing items, you should correct them as soon as possible.
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Be meticulous in checking the source documents to properly categorize the transactions. Do a monthly reconciliation of bank statements vs books and check the reason for variance if any. Prepare a good schedule for the month-end closing for easy monitoring and review the financial reports (balance sheet & income statement). With that, the business owner will have a sound decision making and confident in numbers.
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2 Categorize your cash flows correctly
One of the most common errors in cash flow statements is misclassifying cash flows into the wrong categories. For example, some businesses may record interest payments as operating cash flows instead of financing cash flows, or vice versa. This can distort your cash flow analysis and affect your financial ratios. To avoid this, you should follow the guidelines and definitions of the accounting framework you use, such as GAAP or IFRS. You should also check the nature and purpose of each cash transaction and assign it to the appropriate category.
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3 Use the indirect method for operating cash flows
There are two methods to calculate your cash flows from operating activities: the direct method and the indirect method. The direct method shows the actual cash receipts and payments from your business operations, while the indirect method starts with your net income and adjusts it for non-cash items and changes in working capital. The indirect method is more widely used and preferred by most investors and analysts, as it provides more information and insight into your business performance and profitability. It also reconciles your income statement and balance sheet, which helps you ensure cash flow statement accuracy.
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4 Reconcile your cash flows with your bank statements
Another way to ensure cash flow statement accuracy is to reconcile your cash flows with your bank statements. This means that you should compare the cash balance at the beginning and end of the period in your cash flow statement with the corresponding figures in your bank statements. If there are any differences, you should identify the reasons and adjust your cash flow statement accordingly. Some of the common causes of differences are timing differences, bank fees, interest income, bank errors, or fraud.
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5 Use accounting software and tools
Preparing a cash flow statement manually can be time-consuming, tedious, and prone to errors. To save time and improve accuracy, you can use accounting software and tools that automate the process and generate cash flow statements based on your income statement and balance sheet data. You can also use templates, formulas, and functions in spreadsheet programs like Excel or Google Sheets to create and update your cash flow statement. However, you should still review and verify the results and make sure that they comply with the accounting standards and principles.
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6 Here’s what else to consider
This is a space to share examples, stories, or insights that don’t fit into any of the previous sections. What else would you like to add?
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Ensuring the accuracy of the cash flow statement is vital for sound financial management. Start by meticulously recording all cash transactions in a well-structured accounting system. Reconcile cash balances regularly with bank statements. Implement strong internal controls to prevent errors and fraud. Verify the classification of cash flows as operating, investing, or financing activities in line with accounting standards. Periodically review and reconcile accounts receivable and payable to align with actual cash movements. Continuously monitor cash flow trends and investigate any significant variances. Regularly engage with other departments to understand upcoming cash requirements.
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After all the reconciliations and verification of each preparation of Cash Flow Statements the user or one the is preparing it should review and inspect it from the aspect as does the statement aligns with its general understanding and yearly transaction of the business and organisation.Example: A manufacturing organisation has took a term loan to procure machineries during a year it has affected its investing, financing activities and additional capacity has increased its operational activities and quick overview of material business transaction and general understanding of business and its alignments with cashflow statements.
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