Cash is king! That’s what we all learn in Accounting 101. And every business owner knows that cash is the heartbeat of the business. Profitable companies can go out of business because they do not have enough cash on hand to pay their debts. This makes it all the more important that you know exactly what is going on with your cash account(s) and why you need to understand your company’s cash flow statement.
Cash flow is the net change in your company’s cash position during a specific period and it is a key indicator in determining your company’s financial health in many ways. Knowing whether or not you have sufficient funds to pay down your future debt commitments, invest in the growth of your company (build/lease new locations, R&D, employee training, etc.) or have greater flexibility to respond to critical decisions, cash flow is critical in understanding your company’s liquidity and its ability to generate and use cash.
There are three major sections to a cash flow statement that breaks out your cash activity:
Operating – Cash flow from operating activities is the cash inflow/outflow that a business produces internally. This covers cash coming in from customers and cash going out for expenses, including inventory and is more of the day-to-day activities of the Company. The operating section also converts the items reported on the income statement and balance sheet from the accrual basis of accounting to the cash basis. For example, a company could have a $500,000 sale on 45-day credit terms. That sale will show up on the income statement, the balance sheet will have an increase in receivables, but there will not be a positive cash flow from this sale because you have not received any cash at this point. While the sales proceeds will ultimately flow into your cash from operations, the money expected from this sale is sitting in receivables at year-end and has not been collected. However, your company will have needed money to fulfil that sales order (whether purchasing inventory or running payroll to service/manufacturing employees) so it’s important to have sufficient cash on hand.
Investing – Cash flow from investing activities most commonly relates to the purchase and sale of fixed assets, but also includes purchase of investment securities and business acquisitions. These activities are separated because they tend to be long-term investments in future growth of the company.
Financing – Cash flow from financing activities relates to moneys received/paid to finance operations or investments in future growth of the company. Cash in consists of debt proceeds, owner contributions (share purchases). Cash out consists of loan payments and distributions (shareholder dividends).
Also, there are cash flow based financial ratios to help get a more accurate picture of the Company’s liquidity, including the cash flow to sales, operation index and operating cash flow ratios. Understanding and utilizing these ratios can play a vital role in keeping the doors to your business open!
John Caillouette, CPA