Small businesses run on cash and knowing where cash is and where it’s gone is among the most important things a business owner can know. The cash flow statement enables the owner, managers, bankers and suppliers to view the company’s operations from a cash perspective, so they better understand how smoothly the operations are running, where growth funding is coming from and how wisely the money is spent.
Cash flow statements confirm whether your business is consistently generating more cash than it spends, your ability to pay off debt, increase your dividend, or even acquire another business is enhanced. A cash flow statement is really important to investors who are trying to determine the viability of your company, particularly its ability to generate cash and pay bills.
The three common classifications on Cash Flow Statements include cash provided or used in:
Operating Activities – transactions from the daily operations of the business like receiving money for goods and services and paying operating expenses. Your main cash flow should be generated from operating activities.
Investing Activities – Activities involving the acquisition and sale of fixed assets (building and equipment) but can also include stocks and other investments if not held for resale as a primary business activity.
Financing Activities – Activities include borrowing and repayment of long-term liabilities or changes to owners’ capital (i.e. contributions, distributions, stock issuance and purchase).
The Importance of the Cash Flow Statement
A Profit and Loss statement does not reveal hidden problems, like insufficient cash flow. Earnings only provide information about money coming into the business, cash flow is a statement addressing how a business receives money (from its sales and investments) as well as the ways in which it spends money (on operating expenses, capital investments, taxes and interest). In other words, cash flow is more than just measuring over-the-counter revenue.
Cash can come from both internal and external sources, and the Cash Flow Statement helps companies and investors separate and observe the differences and extent of the cash inflows and outflows. Internal cash sources provide a company with successful attributes and assurances that include:
1) preventing and monitoring company debt
2) preventing unnecessary expenditures from interest, late payment penalties and debt costs
3) ensuring timely investment and cash available for investment opportunities
4) ensuring timely payment of expenses and debts
5) and most importantly — ensuring a level of regular business income without relying on outside investment or cash borrowing.
Periodic review of the cash flow statement for rapidly growing companies can identify the need for cash and use financing to cover the shortfalls. A troubled company could head off financial distress by noticing negative operating cash, minimal investing cash and significant financing cash flow. The owner who sees this could restructure operations and revamp the financing structure.
If your company isn’t doing a good job of managing the amount of cash entering and exiting, you may be setting yourself up for failure. A business will struggle to keep its doors open if it lacks the cash to manage operations and cover day-to-day liabilities.