by Michael Iverson
Check out this sample Cash flow statement for Acme Company
It’s my observation that most business owners review their financial statements in the following order:
- Income Statement
- Balance Sheet
- Statement of Cash Flow
Why is that so? Perhaps the most likely reason is that business owners borrow money. The lenders from whom they borrow focus on Income Statements and Balance Sheets, so those reports naturally become important to business owners.
However, when it comes to business planning and improving business results, I encourage clients to first look at the Statement of Cash Flow. As I’ve stated in previous articles, cash flow is often the most challenging metric for a small business to master. Balancing growth against the availability of cash is one of the most critical issues for a small business. Getting it wrong can put the business in peril.
Components of the Report
Unlike the Income Statement and the Balance Sheet, the Statement of Cash Flow is not based on accrual accounting. Rather, the report shows how a company generates cash and how its cash is spent. The concept of accrual accounting is matching the expense to the period when the obligation occurs or revenue to the period when it is earned. The cash flow statement is only concerned when a bill is paid or revenue is received.
The report has three component parts: Cash Flow from Operating Activities; Cash Flow from Investing Activities; and Cash Flow from Financing Activities.
- Cash Flow from Operating Activities includes cash receipts from customers less amounts paid to suppliers and employees. The company in the example is generating healthy cash flow from its core operations.
- Cash Flow from Investing Activities shows a net cash outflow due to equipment purchases, which could be expected for a growing company.
- Cash Flow from Financing Activities is a large net cash inflow due to capital contributions and proceeds from a sizeable loan.
Check out this example for the ACME Company: Cash flow statement
Improving Business Results
In the space of one year, the ACME Company in the example cash flow statement markedly improved its cash position. The beginning cash balance of $22,000 increased to $176,000 by year’s end.
During the same time span, the company invested in new equipment and replacement equipment. The new equipment might have been necessary for a new product line. The replacement equipment ensures against any unplanned disruption of existing production capacity. It appears that the company has prepared for continued growth over the next few years. With healthy cash flow from its core operations, the company is poised for growth opportunities.
Of course, there are risks involved with any new initiative or product introduction. Perhaps the new product line won’t do well which could put pressure on repaying the loan. To help mitigate those risks, setting aside cash as a reserve affords some breathing room if new initiatives don’t work out.
What is your Statement of Cash Flow telling you about your business? Have you achieved a cash position that provides a reasonable cushion for unforeseen events? If an incredible growth opportunity presented itself today, would you be able to act decisively?
If you would like to discuss how your business is positioned, contact us. We’re glad to help you create and interpret your Cash Flow Statement.