The cash flow and balance sheet can be linked by looking at balance sheet movements. An understanding of this connection allows a business to control it’s cash flow by controlling the balance sheets.
Cash Flow
Typically a simple cash flow statement for a business is along the following lines.
| Beginning cash balance | 30 |
| Cash receipts | 350 |
| Cash payments | -305 |
| Cash Flow | 45 |
| Ending cash balance | 75 |
What this cash flow statement tells us is that the ending cash balance is equal to the beginning cash balance plus cash receipts less cash payments. If we rearrange this we have:
So the cash flow is simply the difference between the beginning and ending cash balances.
The table below shows the beginning and ending balance sheets of a typical business, and in the final column shows the movement between the two balance sheets. The presentation has been simplified for the purpose of this explanation.
Beginning and Ending Balance Sheets
| Balance sheet | Begin | End | Change |
|---|---|---|---|
| Fixed Assets | 200 | 550 | 350 |
| Cash | 30 | 75 | 45 |
| Accounts receivable | 50 | 90 | 40 |
| Inventory | 45 | 80 | 35 |
| Accounts payable | -60 | -85 | -25 |
| Loans | -120 | -450 | -330 |
| Net assets | 145 | 260 | 115 |
| Capital | 100 | 150 | 50 |
| Retained earnings | 45 | 110 | 65 |
| Equity | 145 | 260 | 115 |
The blue highlighted row shows the beginning and ending cash balances and the cash movement. We can see that the cash movement between the balance sheets is the ending cash balance (75) less the beginning cash balance (30) which, comparing this to the cash flow statement above, is the same as the cash flow (45), so the link between the cash flow and balance sheet is:
Careful monitoring of balance sheets and balance sheet movements will therefore allow a business to control cash flow.
Cash Flow and Balance Sheet and the Accounting Equation
The accounting equation tells use that the assets of the business must always be equal to the liabilities plus the equity of the business.
Since cash is one of the assets included in the accounting equation we can rearrange the equation as follows:
Assets = Liabilities + Equity Cash + Other assets = Liabilities + Equity Cash = Liabilities + Equity - Other assets
Since we know from above that the cash flow is the same as the change in the cash balances on the balance sheets.
Cash = Liabilities + Equity - Other assets Change in Cash = Change in Liabilities + Change in Equity - Change in Other assets
So the cash flow of the business can be determined by looking at the changes in the balance sheet liabilities, equity, and other non cash assets, which is the basis for the indirect cash flow statement.
About the Author
Chartered accountant Michael Brown is the founder and CEO of Plan Projections. He has worked as an accountant and consultant for more than 25 years and has built financial models for all types of industries. He has been the CFO or controller of both small and medium sized companies and has run small businesses of his own. He has been a manager and an auditor with Deloitte, a big 4 accountancy firm, and holds a BSc from Loughborough University.