Understand the Cash Flow Statement

“Our Income Statement shows that we are profitable, but how come our company is always strapped for cash?” This is a common question I get from managers and business owners alike. And I always tell them that the Cash Flow Statement is one place to look for answers. This financial statement is one of the reports mostly overlooked especially by small business owners. Most of the time, they are not even aware that this financial statement is one of the basic reports they should be getting from their accountants.

The Cash Flow Statement shows the actual cash generated by the company for a given period. It is primarily composed of three main categories:

Funds generated from or used in operations
Investments made by the company
Financing transactions

Cash Flow from Operations

This category revolves around four activities:

Collections from customers
Payments to suppliers
Other operating cash outflows such as sales & marketing and administrative expenses and interest payments
Cash tax payments

A positive net cash flow from operations means that the company’s core business operations is able to sustain itself – the collections from customers are enough to cover the day-to-day needs of the business.

A negative net cash flow from operations means that the cash inflows from the company’s operations are not enough to cover the daily costs and expenses. This is quite expected for companies who have just recently started operations because efforts are still focused on sales and marketing to build customer base. But management should always work to improve the net cash flow from operations to assure investors that management is effective in controlling the financials and operations of the business.

Cash Flow from Investing Activities

This section usually shows the amount of cash spent by the company on capital expenditures, such as new factory equipment or business expansions. This section also includes other monetary investments (such as money market funds) and acquisitions of other businesses.

There is a negative net cash flow from financing activities if the company put money into investments during the period. It is good to see a company re-invest some of its profits back into the business to cover depreciation of its fixed assets and/or to finance business expansion.

Conversely, the net cash flow from financing activities is positive if the company liquidated or sold some or all of its investments. This may sometimes be required to generate funds to augment the operational requirements of the business. Liquidating investments is better compared to borrowing funds from the bank or other creditors because the company will not have to pay interests.

Cash Flow from Financing Activities

This section shows the outside financing activities undertaken by the company. The cash inflows from financing activities pertain to additional capital from investors or from borrowings from the bank or other creditors.

The cash outflows from financing activities, on the other hand, result from repayments of bank loans and other borrowings and/or cash dividend payments given to investors.

Effective Cash Management

A big part of running a business is managing the funds. You need to make sure that your company’s cash inflows are timely and enough to cover your cash outflows. Your company will be attractive to potential investors when they see that your over-all operations produce adequate free cash flow (FCF). Free cash flow shows that your company has the ability to pay debts, pay dividends and facilitate the growth of the business.

A regular analysis of the cash flow statement will enable you to determine the working capital required by your operations. You will also see if your operations are generating enough cash and if you have extra funds either to expand your business or in acquiring other investments. You will also be timely prompted if you need to get additional funds either from your investors or creditors.

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