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Don't Overlook the Cash Flow Statement

by Sherry Walters

One of the most important numbers that business owners and their stakeholders should know is the Company’s cash flow from operations, which is often overlooked in lieu of the income statement and balance sheet numbers.  Being able to internally generate sufficient cash is key to maintaining a healthy business.  A Statement of Cash Flows serves as a map that tells where cash came from and where it went, and is a crucial planning tool for any business’s long term success.

In addition to reporting cash flow from operations, the cash flow statement can highlight other key factors to consider in a business's strategy.

  • A cash flow statement shows if a business is running out of money, even if it is profitable at the same time.  Fast growing businesses often show a net income but have their cash tied up in accounts receivable or rely too heavily on bank financing.
  • A cash flow statement will tell if the owners are taking too much money out of the business, which is not something you would see on the income statement.  Distributions should not exceed cash flow from operations.
  • A cash flow statement makes clear how much money was used to purchase property and equipment, another thing you won’t find on the income statement. It’s important to know the cash impact that fixed asset investments have, since net income can be significantly affected by depreciation and amortization.
  • A cash flow statement can tell you how loan payments affect cash in the bank.  While interest payments are reported on the income statement, principal payments are not; both are reflected on the cash flow statement.  Knowing how much cash is needed every month to make monthly loan payments can help with better planning.

If cash flow from operations is declining, too small, or even negative, it is important to evaluate the following areas of business for improvement.

Accounts Receivable – How many days does it take, from the date a product is shipped or a service performed, to receive payment?  If this number is too high, it can jeopardize the ability to remain a going concern. Shorten the billing cycle by invoicing more frequently, calling customers regarding delinquent accounts after 30 days or offering sales discounts for quicker payment.

Inventory – How many times a year does inventory turn over?  Selling inventory more quickly requires less cash because there is less inventory on hand at any particular time.  Inventory turnover applies to more than just the sale of a physical product.  In the service industry, it can be how efficiently employees and equipment are utilized.

Accounts Payable – How quickly are incoming bills being paid?  While quick payments may be necessary to take advantage of purchase discounts or maintain good relationships with suppliers, some vendors may offer no incentive to pay before the invoice due date. In this case, wait until the due date to pay bills to avoid prematurely depleting cash.

It's hard to over-emphasize the importance of the cash flow statement. Savvy investors and lenders know the bevy of information available on this crucial report. Don't overlook its impact on a business and use it to make more informed financial decisions.

December 12, 2012