by Michael Iverson
In a recent article, I discussed a company that had greatly improved its cash position in a year’s time. To complete the discussion, it’s important to consider reasons why a company’s cash position might deteriorate from one year end to the next
Take a look at the following Statement of Cash Flow:
Statement of Cash Flow for ABC Company for the year ended December 31, 2013
Cash Flow from Operating Activities
Cash receipts from customers 568,000
Cash paid to suppliers and employees (622,200)
Cash generated from operations (54,200)
Interest received 500
Interest paid (1,200)
Taxes paid (2,900)
Net Cash Flow from Operating Activities (57,800)
Cash Flow from Investing Activities
Equipment additions (10,500)
Replaced equipment (24,200)
Proceeds from sale of equipment 1,900
>Net Cash Flow from Investing Activities (32,800)
Cash Flow from Financing Activities
Proceeds from capital contributions 12,100
Repayment of loan (19,300)
Net Cash Flow from Financing Activities ( 7,200)
Net Increase/Decrease in Cash (97,800)
Cash at January 1, 2012 122,600
Cash at December 31, 2012 24,800
In the statement above, the Cash Flow from Operating Activities is a negative number. As you can see, cash receipts from product sales are exceeded by the cash paid to company employees and suppliers. That’s not a good sign.
The objective of any business is to generate cash sufficient to cover all expenses and pay owners/investors a reasonable return. In this instance, the product sales for the business didn’t quite meet the costs associated with manufacturing and selling the product. Unfortunately, there were no returns on investment for the owners and investors.
Rapid Depletion of Cash
Looking at the cash balances at the beginning and ending of the year ($122,600 to start the year vs. $24,800 at year’s end), the healthy cash balance at the start of the year was seriously depleted by year’s end. The situation is serious enough to threaten the viability of the business.
The problem is the company’s negative Cash Flow from Operating Activities. By reviewing the year’s budget, we could determine the extent to which actual Sales for the year fell short of budgeted Sales. If actual Sales fell short of budgeted Sales, we would further examine the reason(s) why.
The other possibility is that the Sales was fine, but collections for products sold fell far short of expectations. In other words, product sold and delivered was not paid within the payment terms provided to customers.
Cash Flow from Investing Activities shows that equipment purchases totaled $34,700, increasing the negative cash flow. Since equipment purchases could include both replacement equipment and new additions for product expansion, these investments can put a further strain on the business.
Capital Contributions Required
The owners contributed $12,100 in capital during the year, however, loan repayments used $19,300 of cash. Are there more loan repayments due in 2014 and beyond? If so, then the owners will likely be required to contribute in 2014, assuming the cash flow from operating activities continues to be negative.
Borrowing money from a bank will be difficult given the company’s poor cash flow.
Keep a close eye on your Cash Flow from Operating Activities and understand the drivers of this number. This knowledge can be the difference between staying in business and going out of business.
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.