The Cash Flow Statement...Can We Pay Our Bills?
It would not be fair to start this post without highlighting the importance of understanding the Cash Flow Statement especially to entrepreneurs and new business owners at the beginning of their ventures. Many businesses fails because people fail to understand Cash Flow Management. Entrepreneurs and business owners often mistake cash and profit however they are not the same. I read the following example and thought it might resonate . Profit is like food while Cash is like Oxygen. if you don't eat for the rest of the day you will still be alive, you will be hungry and maybe in a bad shape but alive nonetheless. However, if you don't get Oxygen even for few minutes and you won't survive. That's true for a business as well. a Business that runs out of cash can not survive, services are cut off, unpaid staff will stop working, overdue suppliers will stop supplying material ... you get the picture. So Let's keep that in mind when we dive into understanding one of the most important yet highly overlooked statements -- The Cash Flow Statement.
Definition: The Cash Flow Statement - also referred to as Funds Flow Statement -is asummary of the actual or anticipated incoming and outgoing of cash over an accounting period. It assess the amount, timing and predictability of cash-inflows and cash-outflows and is used as basis for budgeting and business planning.
How is the Cash Flow Statement Organized?
After the Heading which contains the company name and the period when the financial data was recorded, the Cash Flow Statement is divided into three main sections:
Operating Activities - Measuring the cash inflows and outflows caused by core business operations, the operations component of cash flow reflects how much cash is generated from a company's products or services. Generally, changes made in cash, accounts receivable, depreciation, inventory and accounts payable are reflected in cash from operations.
Investing Activities - Changes in equipment, assets or investments for example to buy "cash out" new equipment, buildings or short-term assets such as marketable securities. However, when a company divests of an asset, the transaction is considered "cash in".
Financing Activities - Changes in debt, loans or dividends are accounted for in cash from financing. Changes in cash from financing are "cash in" when capital is raised, and they're "cash out" when dividends are paid. Thus, if a company issues a bond to the public, the company receives cash financing; however, when interest is paid to bondholders, the company is reducing its cash.
What Information can we get from the Cash Flow Statement?
How the business is generating its cash?
Is it from its core business of providing goods and services ( which is the best way for a successful business)? (CFO)
Is it from selling buying and selling assets such as machines, building sand land? (CFI)
Is it from selling equity in the company or incurring debt? (CFF)
The ultimate scenario is for businesses to generate the largest portion of their cash from the day-to-day operating activities with minimal reliance on outside financing.
How the business use its money and where its priorities lie?
Is it in growth mode hence spending on purchasing equipments?
Is the business distributing wealth to owners (via Dividends), or use the proceeds to generate more growth.
How Liquid is the organization?
How much cash does the business have this year compared to the previous couple of years?
Is the Net Income reported on the Income Statement realized in cash?
If the "operating" income and the "operating" cash figures have a huge gap then you should ask some tough questions about inflating income or deflating expenses.
