In our experience, few small companies are careful to report their Statement of Cash Flows along with their Income Statement and Balance Sheet every month. This is an unfortunate missed opportunity to better understand your business and what matters most – cash generation over time.
We strongly recommend that CEOs regularly review their company’s cash flow statements, a core tool in getting a handle on the cycle of inflows and outflows that stem from operating the business.
Elements of a Cash Flow Statement
A cash flow statement comprises three basic parts:
- Operating cash flow: This is the difference between the money generated by your company’s daily operations and the cash used to pay suppliers and to cover other business expenses. Operating cash flow can be a better measure of a company’s profits than earnings. In some instances, an income statement can show positive net earnings while the company is still unable to pay its debts.
- Investment cash flow: This shows changes to your company’s cash position from buying or selling assets — for example, selling and replacing company vehicles or acquiring equipment. It also includes buying and selling stocks, bonds and other securities, as well as lending money and receiving loan payments. Other sources of income are also included. For example, if you operate a beauty salon and rent out an extra room as storage space, the income received is investment cash inflow. There will likely be times when your company shows little investment cash flow but, over time, investment cash flow data will help you assess how you’ve been using the cash your business generates.
- Financing cash flow: While operating and investment cash flow are generated from operations, financing cash flow is derived from outside sources such as investors, shareholders and lenders. Financing cash flow includes net borrowing from lines of credit, new borrowings, loan repayments, principal payments under capital lease obligations, dividends or cash distributions, proceeds from issuing stock, and capital contributions from partners or owners. So, for example, issuing new stock is a financing cash inflow, while paying off a loan is an outflow.
Cash flow statements also highlight important distinctions, such as the differences between cash and sales or inventory. A ledger full of credit sales might look good, but that won’t help if you can’t pay your employees until you collect on those accounts.
Great Potential, but …
By the same token, a warehouse full of inventory might represent great potential, but the electric company wants to be paid in cash — not with a gross of glow-in-the-dark shoehorns.
On occasion, after analyzing your company’s cash flow statement, you should create a cash flow projection.
This is an important cash management tool that lets you see when expenditures are likely to be too high or when you can expect a cash surplus and a potential opportunity to arrange some short-term investments. The cash flow projection also provides good insight into how much capital investment your business might need.
Cash flow statements and projections help your business in other ways, too:
If you’re going to approach a lender for financing or potential investors for a cash infusion, they’re going to want to see a cash flow statement based on generally accepted accounting principles (GAAP), as well as a cash flow projection based on industry averages, solid business assumptions and market trends.
Over time, cash flow statements demonstrate how you’ve managed your available cash. If you’ve borrowed from the lender before, the loan officer is going to want to see what you did with that earlier amount. If you managed the money well, your cash flow statement will provide the evidence.
If your business hits seasonal low cash cycles every year, cash flow statements and projections will highlight those periods.
With that information you can shop around for low-interest, short-term financing to help keep your company running smoothly through those anticipated lean times. If your business hasn’t projected those cash crunch cycles, your choices become limited. You could wind up letting your bills slide and damaging vendor relationships, or you mind find yourself scrambling to arrange emergency financing that’s likely to carry a high interest rate.
Knowing when you’re approaching the threshold of a traditionally high- or low-cash period also can help you determine the optimal time to launch a new product or service or to trim or expand your company’s staff.
Six Months Down the Road
What’s more, a well-executed company’s cash flow projection can show you, as well as potential lenders and investors, what to expect six months or a year from now. Cash flow projections are the key to making smart and profitable business decisions.
Some business owners ask: My company’s financial statements include an income statement. Why do we need a cash flow statement, too?
The reason is because some expenses don’t show up on your income statement for quite a while. For example, you might spend considerable sums of cash to beef up your inventory but, until that warehouse stock translates into sales and costs of goods sold, your income statement won’t t reflect the purchases.
Similarly, while you might be celebrating the fact that you paid off a large business debt and improved your company’s balance sheet (another component of your financial statements), unless the interest you were paying on the debt was enormous, your income statement probably won’t show much of a difference.
Moreover, certain expenses don’t affect cash flow — such as depreciation, amortization and depletion. These items need to be adjusted for on your company’s cash flow statement.
On Hand, At Your Fingertips, Every Month!
Properly generated financial statements, which should include a sound cash flow statement, are critical to tracking you company’s performance and obtaining outside financing.
About Scale Finance
Scale Finance LLC (www.scalefinance.com) provides contract CFO services, Controller solutions, and support in raising capital, or executing M&A transactions, to entrepreneurial companies. The firm specializes in cost-effective financial reporting, budgeting & forecasting, implementing controls, complex modeling, business valuations, and other financial management, and provides strategic help for companies raising growth capital or considering M&A/recapitalization opportunities. Most of the firm’s clients are growing technology, healthcare, business services, consumer, and industrial companies at various stages of development from start-up to tens of millions in annual revenue. Scale Finance has multiple offices in the Carolinas including Charlotte, Raleigh/Durham, Greensboro, and Wilmington with a team of more than 45 professionals serving more than 130 companies throughout the region.