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Cash Flow Statements

Cash-Flow Statements

The primary financial consideration regarding growth is cash flow. Growth typically costs money before it brings it in, which means a business experiencing growth needs a source of excess cash. But cash is not the same as profit. If you get a loan from the bank, for example, your cash reserves will instantly go up but your profits will not. On the other hand, if you make a sale on credit your profits will go up but your cash reserves will not, at least not until the invoice is paid.

At its most basic level, a business does two main things: generate cash and spend cash. As long as the cash balance remains positive the business is secure, but if the cash balance turns negative the business puts itself at risk of failure. The surest way to monitor the flow of cash through your business is with a Cash-flow Statement.

Cash-flow Statements are valuable when you need to keep a close watch on your cash balance. This is especially true when cash is tight, for example, during times of growth, the start-up phase of a business, or when profit margins are small. But it's also true when a business has more cash than it needs. In this case a Cash-Flow Statement can help keep a successful business strong and lean. Whenever possible, excess cash should be invested in some fashion, not left in a bank doing nothing. (See the Opportunity Cost of Capital section from Chapter One.)

Liquidity is the convertibility of an asset into cash without a significant loss in value. Bonds, for example, are more liquid than equipment because they are more easily converted into cash. Of course, cash is the most liquid commodity. Your liquidity represents your ability to cover your current debts.

Because a Cash-flow Statement focuses strictly on cash, it's also your best source of information concerning the immediate liquidity of your business. The less liquid a business is, the greater the risk of it not being able to cover its debts. The more liquid a business is, the more flexibility it has for considering new investment opportunities.

The “Assets” section of your Balance Sheet shows the amount of cash your business has at the end of each accounting period. While this total can be compared from month to month, it offers little explanation as to why any changes have occurred.

A Cash-Flow Statement identifies the source from which cash has come into your business and on what your cash has been spent. In many ways it's like an Income Statement focused strictly on cash, showing the inflow and outflow of cash for an accounting period. It's also a little like a Balance Sheet, showing the balance of your cash account at the beginning and end of each accounting period.

When comparing your Cash-Flow Statements to your Income Statements and Balance Sheets, remember the following:

  1. Depreciation, Shrinkage, Amortization, etc. are not a cash-related items. While it's true as they get older assets often diminish in value, they have no effect on your cash flow until they are sold.

  2. The “principal” portion of debt re-payment must be documented on your cash-flow statement because when it is paid, cash leaves your account.

  3. Any inflow of cash from a loan must be recorded on your cash-flow statement.

  4. Revenue is not necessarily cash. It becomes cash only when the actual payment is received, prior to that it is still a receivable.

Up-to-date Cash-flow Statements provide information concerning your liquidity, making you aware of possible trouble before it's too late. As a result, you may be able to put off a purchase or arrange for better payment terms if, for example, you are short of cash and know you need to pay your rent next week.

Cash-flow Statements record the inflow and outflow of cash for your business. This can be broken down into three basic categories.

Operating Activities — These include the cash effects of income generating transactions such as the sale of goods and services, inventory purchases, salaries and tax payments.

Investing Activities — These include the cash effects of acquiring and selling non-cash equivalents, such as property, equipment and loans made to others.

Financing Activities — These include the cash effects of borrowing money and the repayment of principal to lenders, including you, the owner.

Following is a brief outline of the anatomy of a Cash-flow Statement.

Starting Cash — This is your cash on-hand at the start of the period. It includes petty cash, cash in the bank, and any other cash or cash equivalents such as bonds that can be instantly converted into cash.

Sales Receipts (Sales Revenue adjusted for receivables) — This is any income you have received in cash plus any receivables that have been paid during this period.

Other Receipts (Other Revenues adjusted for receivables) — This is any cash, or cash-equivalent, you have received during the period, from sources other than sales.

Total Cash Receipts (Sales Receipts plus Other Receipts) — This is your total cash income for this accounting period.

Total Available Cash (Starting Cash plus Sales Receipts plus Other Receipts) — This is the total amount of cash available for covering your expenses during the period.

Variable Disbursements (Variable Expenses adjusted for payables) — This is the total cash you have paid out to cover your Variable Expenses (expenses that vary with sales) this period.

Fixed Disbursements (Fixed Expenses excluding depreciation) — This is the total cash you have paid out to cover your Fixed Expenses (expenses that change infrequently) this period.

Other Disbursements (Other Expenses adjusted for payables and depreciation) — This is any cash you have paid out for expenses not directly related to the business operations, such as the purchase of an investment property.

Debt (principal payments) — This is any cash used to pay down the principal portion of a loan during the accounting period.

Total Cash Disbursements (Variable Disbursements plus Fixed Disbursements plus Debt payments) — This is your total cash outlay for the accounting period. Net Cash Flow (Total Cash Receivables minus Total Cash Disbursements) — This is the total increase or decrease in your cash during the accounting period.

Ending Cash (Total Available Cash minus Total Cash Disbursements) — This is your cash on hand at the end of the accounting period. It becomes your Starting Cash for your next accounting period.

Review your Cash-Flow Statements from the past six months.

Timing — You should receive and review cash-flow statements regularly. Depending on the size of your business, quarterly may be an adequate schedule. How often do you currently receive them?

Do you receive them expediently? The longer you wait to review your financial reports the less up-to-date you are on your financial status, so try to have them available as soon as possible.

Accuracy — Mistakes are annoying, take time and resources to fix, and give you a false impression of your financial status. How accurate are your Cash-Flow Statements?

Detail — Have you included enough detailed information on your Cash-Flow Statements? How detailed should they be for your needs?

Layout/Format — Are your Cash-Flow Statements simple and clear?

Now note any changes you would like to make to your current format.

Update your Cash-Flow Statements with the changes you noted previously. If you do not currently have one, now is the time to make one.