Up and to the Right | 2016 Week 49 | Statement of Cash Flows

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Cash is king as they say and the Statement of Cash Flows is a key report that bridges the gap between the Balance Sheet and the Income statement.

In this episode of Up and to the Right I'll discuss how to get the most out of the Statement of Cash Flows without investing hours of time or going to night school to understand the accounting behind it.

I've provided some examples of both the entries on this report and the calculations used to arrive at the numbers. The point; however, is to understand that the Statement of Cash Flows is the best indicator of how cash works its way through your business.

Intro Video

Listen & Download

Resources

Worksheet

There will be a financial analysis spreadsheet in Week 50's episode.

Tool of the Trade

Refer back to the 2016 Week 47 episode for a list of accounting tools. Let's get through week 50 and talk about new tools in Week 51; after all, we've all got a lot on our plates!

Bonus Tip: Check out the forward looking Cash Flow Projection Report in Quickbooks (other systems may also include this). This can help you identify potential tight cash points before they happen.

Reading Room

The Willpower Instinct by Kelly McGonigal

Get it on Audible here: The Willpower Instinct

Get the dead tree version here: The Willpower Instinct

Show Notes

Hooray! Up and to the Right 2016 Week 49 clocked in at just over 27 minutes! That's about how long I want them to be so it's a step in the right direction. For everyone who slogged through Week 48 my thanks!

This week we dive into the world between Income Statement and Balance Sheet and discover how cash moves through our business.

Why can't we just look at the Income Statement to understand how well our business is doing?

Generally Accepted Accounting Principles (GAAP) provide guidelines regarding the way accounting is performed and reported. What matters to us as small business owners is understanding how those standard reports reflect the health of our business.

What is an Statement of Cash Flow?

In short the Statement of Cash Flows begins with the Net Profit (from the Income Statement) and provides adjustments for the changes in specific Balance Sheet accounts such as:

  • Accounts Receivable
  • Accounts Payable
  • Inventory
  • Employee Vacation
  • Depreciation
  • Equity (company ownership)
  • Long Term Debit (business loans)

While this list isn't all inclusive it should give you an idea of the type of balance sheet accounts that impact cash and are shown on the Statement of Cash Flow.

The following three categories are generally found on the Statement of Cash Flow.

  • Operating Activities
  • Investing Activities
  • Financing Activities

Operating Activities

These are regular recurring areas of operation:

  • Accounts Receivable
  • Accounts Payable
  • Inventory
  • Employee Vacation

The values that you will see on your Statement of Cash Flow represent the change in the amount from month to month. For example: if you had $10,200 in Accounts Receivable (AR) at the end of November and $12,800 in AR at the end of October you would subtract the current month's AR (November) from the prior month's (October) to get:

October-November=Effect on Cash

$12800-$10200=$2,600

What you will see on your Statement of cash flow is a negative adjustment on your Statement of cash flows. 

Why?

At the end of October the total amount owed to you by your customer's decreased by $2,600 or to put it a different way you collected $2,600 in cash more for November than you extended in credit during the same time.

The result is that cash increased by $2,600. Since collection of Accounts Receivable is not reflected on the Income Statement we add an adjustment for it on the Statement of Cash Flows.

If that's confusing, you're in good company and don't sweat it too much. Any decent accounting system will provide this report so you don't need to be fluent in the calculations to get the value out of the report.

Investing Activities

These entries account for expenses related to fixed assets (durable goods we use in our business that last a long time: industrial machinery, high end computers, professional cameras, vehicles, ovens, hydraulic lifts... etc.).

We call the monthly expense related to these items 'Depreciation' and the Balance Sheet account related to this is called Accumulated Depreciation.

Since depreciation is not actually a cash expense we adjust for it's impact on the Net Income with entries in this section of the Statement of Cash Flows.

The calculations for this are similar in principle to the one described earlier.

Financing Activities

Finally, we have what we call 'Financing Activities' that are related to changes in Equity (company ownership) or long term debt such as business loans.

Again we find that the calculations adjust for expenses shown on the Income Statement that do not have a corresponding cash outlay. Or, the influx of cash from an activity that is not part of the normal course of business such as the acquisition of a loan or the sale of stock. Both of which would increase cash on the Balance Sheet but have no corresponding Income Statement entries.

Why Should I Review It?

By now you've seen that while the Income Statement shows the effect of Revenue (Sales) and Expenses it falls short when it comes to understanding cash flow.

Looking over the Statement of Cash Flows will provide you with a complete picture of the way cash is working it's way through your company.

Takeaways

When you review the Statement of Cash Flows you'll find the three sections we discussed. Beginning the Net Income (from the bottom of the Income Statement) the adjustments are then applied by each of the three categories. Each category ends with something like "Net cash provided by Operating Activities" or something like that.

In an ideal world all three of these sections will provide a positive number meaning that the adjustments showed increases in cash vs. decreases.

The result is that you are increasing the total cash in your business - which is good. Look at items or sections which are negative, these are draining cash from your business.

  • Are you extending too much credit to customers?
  • Purchasing too much inventory?

If you have a question about how an item is affecting your cash give your accountant a call and get the scoop on it right away.