The Statement of Cash Flows (March 2018)

It’s been a while since I’ve written a piece that is technical in nature and deals with understanding financial statements so I suppose that I am overdue. The statement of cash flows is one of the most important, but least looked at financial statements for many businesses. I’ve known many business owners who don’t even get this important piece of information from their accounting and finance team. When that’s the case, they have absolutely no hope of using it as a business tool.

To be clear, a complete set of financial reports includes not only an income statement but a balance sheet and statement of cash flows. To see how these tie together scroll down to The Three Financial Statements on the Visuals tab of my web site.  Further, financial statements need to come with comparatives. Too often I get a single month balance sheet or income statement. That’s simply not a rich enough data set from which to draw meaningful conclusions. Financial information needs to come with multiple references. These should include comparisons to recent periods, budget and last year. For more on this, check out Follow The Trend on my YouTube Channel. It’s less than a minute. I like brevity.

Back to the statement of cash flows; this essential report ties the bottom line of the income statement to the change in cash during the period. For some businesses, this link is pretty tight. If your collections are consistent, you buy most services monthly, have minimal debt payments and capital expenditures, then it’s quite possible that you can run your business just fine by focusing primarily on the income statement although you should still have a statement of cash flows to validate that the link between income and cash generated from operations is as tight as you assume it to be. But even in these somewhat rare situations, the statement of cash flows helps one understand distributions for taxes or other purposes versus how much cash is being left in the business.

For most businesses, where the timing of receipts varies greatly from revenue, there are significant capital expenditures, advance deposit requirements for purchases, debt payments, or other issues there can be significant variation between profit and cash generation. This can be particularly true in fast growing businesses where receivables are growing and are therefore consuming cash.

Too often, I’ve heard business owners lament, “I’m making money, but I don’t have any cash”. First, that business owner’s statement may or may not be a true. In these situations, I’ve often found it to be the case that the income statement is poorly prepared and therefore just plain wrong. The outside CPA, who the company usually engages only for income tax purposes, makes multiple year-end adjustments to produce a tax return and the business owner is often happy to hear that zero or little taxes are due. Consider that a red flag. While sometimes these tax adjustments get flowed back through the company accounting records and sometimes not, the reality is that the business owner should be saying “I don’t have any cash because I’m losing money”. That’s pretty simple and straightforward and much more intuitive.

But in situations where the business is profitable and cash is tight, the answer can be found on the statement of cash flows. The reason could be the result of extended accounts receivable due to either growth or poor collection practices, investments in capital equipment, or perhaps debt payments due to an insufficient capital pool (yes, another link).

On the other hand, if the business is profitable and generating strong cash flows, the statement of cash flows is a useful planning tool to help understand distributions to owners for tax payments, retirement planning or simply to enjoy life.

Whatever the status of your business, be it mature, stable, growth stage, start-up, profitable or not, you should have a solid understanding of the link between the income statement and cash generation which can be found on the statement of cash flows.

If your business could benefit from fractional CFO services, I would welcome the chance to speak with you.  Please give me a call at (314) 863-6637 or send an email to [email protected]

The archive of these monthly newsletters is posted at the Resources section of homza.com

your cash is flowing.  know where.®
Ken Homza
Copyright @ 2018 Homza Consulting, Inc.

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