Understanding the Cash Flow Statement by Tiffany Wright

What is a cash flow statement? A cash flow statement records the cash inflows and outflows from a company. Stated another way, a cash flow statement reports the amount of cash and cash equivalents entering and leaving a company during the specified time frame. This Cash Flow Statement enables the owner, bankers, operational and financial managers, and others to view the company’s operations from a cash perspective. Thus, these people better understand how the company’s operations are running, where the money is coming from, and how the money is being spent. The typical categories on a Cash Flow Statement are as follows: Operations, Financing, and Investing.

The operations section measures the inflows and outflows from core business activities or “operations”. This section is where it is evident that the company can or cannot support itself solely from revenues. If the company can, the net operating cash flow will be positive. If the company cannot, it will be negative. However, this definition can be too simplistic. If the Cash Flow Statement spans 3 months, the net operating cash flow may be positive for the period but may have been negative at the one-month mark. Where then did the funds come from to run the company during the negative period? This is why monitoring the cash and projecting operating cash flow out several weeks and months is so important. If there will be operating cash shortfalls, then the company must generate cash through financing and/or investing activities.

Cash flow is calculated by making adjustments to net income based on whether cash was involved or not. If revenue increased but a large portion of that revenue still resides in unpaid invoices known as accounts receivables, then the amount of increase in accounts receivables over the last period is a decrease in cash. (i.e., More or larger sales on company credit, less cash for the company.) If expenses increased but a large portion of those expenses are in outstanding payables also known as accounts payables, then the company has actually spent less on expenses on a cash basis. (i.e., More expenses but payment terms went from 30 to 60 days so less actually paid during period, more cash for the company.)

Depreciation is a tax expense but not an actual cash expense. Consequently depreciation is always added back to operational cash flow on the Cash Flow Statement.

The financing section measures the inflows and outflows from financing activities such as bank lines of credit or term loans, accounts receivable financing, equipment loans, and other debt instruments. Changes in loans and other debt and dividends are recorded here.

The investing section measures inflows and outflows of the company from investing activities such as equity infusions from the owner, family and friends, angel investors, private equity funds or other investors. This includes money from or distributions to these individuals and entities. The investing section also records purchases or sales of equipment or property or a line of business. Changes in equipment, assets, and investments are recorded here. We have heard of corporations generating cash by selling off a segment of their business. Whether or not the segment was sold for a profit or a loss, that cash sale amount is recorded on the Cash Flow Statement. (Any adjustments to the actual value of the asset are made on the balance sheet and flown through the Income Statement.)

In general, the more cash available from operations, the better. However, if a company is on a strong growth trajectory the net operational cash flow will typically be negative due to the amount of investment (in personnel, software systems, etc.) the company is making to support and propel its growth. In that situation, companies generate much of its cash from financing activities. A large warning sign, therefore, is when a company has negative operating cash flow, minimal or negative investing cash flow, but significant financing cash flow. This is a sign of a struggling, troubled company on a downhill trajectory. Any owner or manager that sees this on their own Cash Flow Statement should take immediate action to revamp its operations and its financing structure.

About The Author

Don’t Envy Those Companies with Financing. Be One! Tiffany Wright - a business advisor and small business owner who has helped small companies procure over $31 Million in financing - has created an easy-to-follow, no holds barred, step-by-step small business financing resource.

Help! I Need Money for My Business Now!! outlines and defines, in layman’s terms, how to obtain business financing despite down economies and credit-challenged markets. In under three months you can access funding. To purchase the ebook, go to http://www.moneytogrowbusiness.com. You can also access more small business financial and management information on her blog at http://www.smallbusinessfinanceforum.com.