Cash Flow Statement: The Best Starting Point for Business Planning

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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:

  1. Income Statement
  2. Balance Sheet
  3. 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.

  1. 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.
  2. Cash Flow from Investing Activities shows a net cash outflow due to equipment purchases, which could be expected for a growing company.
  3. 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.

How Weak Cash Flow Affects Your Business

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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.

Know the Real Flow of Money Through Your Business During a Year

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by Collette Parker

Did you know that almost half of businesses have their best-ever year right before they file for bankruptcy? They grow right out of business, and usually it’s not because of lack of sales – it’s poor management of cash.

“They may have had their best year on paper, but when you look at cash flow and working capital it’s going south real fast,” says Mike Iverson, CPA, and CEO of Trillium Financial.

The old adage is true: you can’t manage what you don’t measure. And even if sales are good, if you have vendors and employees asking for money – but customers who don’t have to pay for another 45 days – it’s a perfect storm for a cash crisis.

“Take the time to do a financial business plan every year,” Iverson says. Not 30 pages, but a simple two-pager with a financial forecast and a budget for 12 months. “That will give small businesses a leg up from those businesses who don’t write this out.”

Visuals help. It’s not enough to just go through a plan in your head. The process of examining your business closely enough to work out a model and a 12-month plan helps you to understand the flow of your business, including issues of seasonality. If you plan cash flow properly you can figure out how much money you can have in hand when you go into manufacturing season, and how much you’ll make in selling season.

“You can’t just set a $12 million goal, and divide the revenue figures by 12 for the year,” says Iverson.

12-Month Trailing Budget

One financial management tool that is useful in managing cash is a 12-month trailing budget versus actual. Once January closes, look at the last 12 months (including January) and chart the revenue. Then look at December and the 12 months prior. Are the numbers higher or lower? Look at the graph. Is it flattening out? Going down?

“Graphing a trailing 12-month is a simple visual tool,” says Iverson, “and can be used for both sales and expenses. If your management team sees a graph instead of a bunch of numbers, they can understand the concept. Hopefully you’re spotting a positive trend. Either way, you can understand what your cash trends are, and then have a budget that is detailed enough to plan.”

Three Key Elements of Budgeting

When planning the budget for healthy cash flow, be mindful of how much is invested in your working capital, and keep track of three key areas:

  1. Accounts Receivables – Unless you are a cash business, chances are you extend credit to your customers. If your terms are 30 days, your customers should pay you within 30 days, not longer. If you begin to see a trend where customers are waiting 45–60 days to pay, you will probably begin to see cash flow problems. Don’t be a free bank for your customers. Look at ways to reduce the time it takes customers to pay you: ask for advances from customers, or a down payment, installment, or some level of prepaid portion of the sale. If you’re in the situation where you really need the cash now, you can work with a factoring firm for receivables, or the bank for a loan.
  2. Accounts Payable – Have favorable credit terms and solid partnerships with your vendors. In this area, you want to hold on to your money as long as you can. But, if vendors offer early payment discounts and you can afford to take it, go ahead. Sometimes, even if you have to borrow the money to pay early, it might make sense to do so. If you can borrow money at eight percent and take a two percent discount for 10 days early (2% 10 net 30), you are effectively earning 36 percent over a year. (If you do that, make sure the borrowing doesn’t put you at risk for running out of cash and not being able to pay your other bills.)
  3. Inventory – Manage your inventory so that it doesn’t sit in a warehouse for too long. Once you’ve paid for the inventory, it should be sold and generate profit for you. Adjust your inventory for the seasonality of your industry so you’re never caught with too much.

An example of good management of these three factors would be to extend 30-day terms to customers, purchase inventory and turn it around in 15 days; and pay vendors in 30 days.

If you would like to discuss more creative ways to manage cash flow, contact us.  We’re glad to share our ideas!