In recent discussions on social media, there has been confusion regarding the term “cash flow statement,” with some posts and training courses conflating two very different concepts under this single term. This misinterpretation often arises from those who may lack practical experience in accounting and financial reporting. In this article, I aim to clarify the two distinct meanings of cash flow statements, highlighting their purposes, and why they shouldn’t be confused.
Two Types of Cash Flow Statements.
1. Broad-Brush Cash Flow Statement (External Reporting):
The first type of cash flow statement is the traditional financial document that most people are familiar with. It reconciles the cash position of a business between two points in time, such as from the start to the end of a financial year. This is a high-level statement that provides a broad view of how cash balances have changed over the period. This type of statement is a core part of the “three-way financial statement” model (along with income and balance sheet statements), often required by accounting standards for external reporting. Its purpose is to give investors and other external stakeholders a snapshot of the cash movements, summarizing how cash was generated and used.
2. Treasury Cash Flow Management (Internal Operations):
On the other hand, treasury cash flow management deals with the day-to-day cash requirements of a business. It involves actively managing cash inflows and outflows, often with a much deeper level of granularity than what is required in the external cash flow statement. This type of cash management ensures the business has enough liquidity to operate smoothly, and when there is surplus cash, it is invested wisely. If cash flow problems arise, treasury management must quickly address these issues, potentially through borrowing, adjusting trading terms with suppliers and customers, or negotiating with banks for overdraft facilities.
The Critical Differences.
The key distinction between these two concepts lies in their scope and purpose:
– **Scope**: The broad-brush cash flow statement focuses on summarizing cash flow over a period, providing an overview for external parties. Meanwhile, treasury cash flow management is concerned with the fine details of cash movements, ensuring there is enough liquidity for day-to-day operations.
– **Purpose**: The purpose of the broad-brush cash flow statement is to inform external stakeholders, such as investors, about the financial health and liquidity of the business over a specific period. It does not delve into the nuances of daily cash flow variations. Treasury management, however, is an internal function aimed at maximizing the efficiency of cash usage within the business, such as timing cash inflows and outflows, investing surplus cash, and minimizing borrowing costs.
Treasury Management: A Complex and Stressful Role.
Treasury management can be quite demanding. It involves making judgments on how to balance cash inflow with outflow, deciding on the commitments for any invested surplus (e.g., whether to invest money overnight or for longer periods like three or six months). Treasury managers must also be adept at navigating unexpected cash flow issues, whether it’s arranging short-term borrowing or adjusting trade terms with suppliers to bridge gaps. This “ducking and diving” requires not only a strategic mindset but also the agility to react swiftly to changing financial conditions, all to optimize the business’s cash position.
The Misconception in Financial Modelling.
Despite these clear distinctions, many financial modelling discussions and training courses fail to differentiate between broad-brush cash flow statements and treasury cash flow management. Many influencers have created extensive content around three-way financial modelling without adequately clarifying these differences. As a result, a significant portion of the audience may end up with a skewed understanding, thinking that cash flow is a single, straightforward concept.
In reality, these two types of cash flow statements serve completely different functions. A funds flow statement required by statutory or regulatory requirements will never require the same level of granularity as internal treasury management. Often it is historic reporting. It is about external interests, while the latter focuses entirely on internal operations. For the here and now, and the foreseeable future. They use the same terminology, but in practice, they are worlds apart.
Conclusion.
The phrase “cash flow” has become a catch-all term that can lead to misunderstandings, especially for those not intimately familiar with the nuances of financial reporting and business operations. It is essential to recognize that a cash flow statement for external reporting purposes is not the same as day-to-day treasury cash flow management. Understanding this distinction can help businesses, analysts, and learners grasp the different financial processes and their respective goals.
For anyone working with financial models, particularly those involved in developing or teaching three-way financial statements, it’s crucial to differentiate between these two concepts. Misunderstanding them can lead to oversimplified models that don’t accurately reflect the reality of running a business. So, the next time someone says, “Cash flow is just cash flow, isn’t it?” you’ll know there’s more to the story.
This is a podcast by Hiran de Silva. Narrated by Bill.
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