As a business owner, financial statements are essential to running your business. Most people are familiar with the Balance Sheet and Income Statement, but I want to outline the importance of another forgotten report, the Statement of Cash Flows.
Many business owners have never heard of this report; therefore, they do not use it. I believe that it is just as important as the Balance Sheet and Income Statements and Profit and Loss Statements. Without the Statement of Cash Flows, you may not have a full picture of your business’s finances.
Essentially, as the name suggests, the Statement of Cash Flows is concerned with the flow of cash in and out of the business. It captures both the current operating results and the changes in the balance sheet.
The importance of the Statement of Cash Flows is that it can help detect if a business is going through financial hardship. A business can have good sales volume and show good profit margins, but if the company can’t pay its bills on time, it’s probably not going to be in business much longer. The Statement of Cash Flows can help you to better gauge where your business stands in terms of cash to prevent this from happening.
So, what is the Purpose of the Statement of Cash Flows?
Simply put, the Statement of Cash Flows gives the user information about the cash receipts and cash payments of the business during the accounting period. Cash can come from many different origins, such as customer payments and loans. The ways a company uses that cash directly trace back to costs (for example, buying equipment, paying invoices, and payroll).
Knowing how a company manages its cash is useful to the business owners. A company may be reporting positive net income period after period, but it doesn’t necessarily mean the company has much cash left over. If a company has cash flow problems, there’s a good possibility that the business won’t be able to give you a good return on your investment.
The Importance of Cash Flow
As previously stated, cash can come from many different sources. The Statement of Cash Flow helps companies separate and observe the differences and extent of the cash inflows and outflows.
It can provide a company with successful attributes and assurances that include:
- preventing and monitoring company debt
- preventing unnecessary expenditures (examples could be late payment penalties and debt costs)
- ensuring timely payment of expenses and debts
- ensuring timely investment and cash available for investment opportunities
- ensuring a level of regular business income without relying on outside investment (loans).
Effectively managing and monitoring cash flows can serve many purposes. Arguably, the biggest reason is to provide owners and managers insight into the company’s cash position.
This knowledge better equips management to make educated and informed decisions on business operations and the need for further investment in the business, such as expansion or newer equipment.
All businesses (of all sizes) try to perfect their cash management. I would like to point out that the Statement of Cash Flows is not the only method of monitoring the flow of cash, but I believe that it is an integral part of the reporting statements and should not be overlooked by business owners.
Why use the Statement of Cash Flows?
Sure, you could review the balance sheet changes to determine the facts, but the Statement of Cash Flows already has all that information integrated into it. This saves time and effort. Business owners that use this report have a better understanding of their finances.
Below are a few examples of how this report helps:
1) A cash flow statement can tell you if you’re running out of money while you’re profitable.
Yes, profits are very important for a small business, but cash is even more important. It’s possible that growing businesses can run out of cash, but also can be profitable at the same time. The Statement of Cash Flows can tell you if this is happening.
2) A cash flow statement can show you if the owner is taking too much money out of the business.
Many small businesses are considered pass through organizations and are taxed as S-Corporations. As such, owners of these companies will often take money out in the form of distributions. Distributions don’t show up on a profit and loss statement, but do show up on a Statement of Cash Flows!
3) You will see the results of letting receivables grow, building inventory, or paying suppliers quickly.
As with the owner’s draw, changes in any of the areas above won’t show up in your profit and loss statement. They do appear in your balance sheet, but you have to understand how to interpret the changes. In a Statement of Cash Flows, they are easy to spot. This helps you understand what’s happening with your cash.
4) Capital purchases show up as an expense.
Again, your profit and loss statement won’t show you if you’re buying too much equipment but your Statement of Cash Flows will. If equipment is needed, you can see clearly how that equipment should be purchased and financed.
5) You’ll see what your loan payments are doing to your cash.
As with equipment purchases, payments to your bank for principal don’t show up on your profit and loss statement.
These changes in your cash can mean your business will run out of money if not managed and budgeted properly! As stated above, they have nothing to do with your profit and loss statement but they have a massive effect on the cash in your business! This could put your business in jeopardy. Every business owner should use the Statement of Cash Flows to more accurately monitor their financial situation.
I include this statement in my monthly financial statement package. This also comes with a monthly consultation to go through your statements and look at all of the positive and negatives.
Now, I would like the opportunity to discuss your situation and how I can help guide you toward financial prosperity. If you’d like to take me up on this offer, please schedule your free 30-minute consultation.
Here’s the deal: I only serve a select handful of clients. I offer a real, hands-on experience, which limits the number of small businesses I choose to work with. If you don’t contact me, that’s totally fine, I understand.
Click here to schedule your free consultation or send me an email directly at email@example.com. I offer a limited number of free consultations so that I may tend to my current clients. So, please take me up on this offer now. I am a bookkeeper which means I am not a pushy sales person. I will be completely honest with you about your situation. After that, if we decide to move forward, that would be great. If not, that is fine as well. You should do what feels right for your business.
I hope this has been helpful and inspires you to take action.