Understanding cash flow statements is key to running any small business. But what are cash flow statements, and how do you read them? Let’s take a look.
What is cash flow?
First, let’s be clear on what we mean by ‘cash flow’. Cash flow is essentially the money that moves through your business. It moves in two directions.
- Cash flows in when customers or clients pay for goods and services.
- Cash flows out when you pay bills and expenses.
Unsurprisingly, you need a way to track this cash flow. That’s where cash flow statements, also known as statements of cash flow, come in.
Here’s what you need to know about them.
What is a cash flow statement?
Every business has at least three major financial statements:
- Income statement
- Balance sheet
- Cash flow statement
The cash flow statement is really important. It shows you exactly how money moved in or out of your business at any given time, whether it’s monthly, quarterly, or annually.
Your cash flow statement shows:
- How much money moves in and out of the business on a day-to-day basis
- How easily you’re generating cash to pay your debts and expenses
In other words, a statement of cash flow shows you where money comes from and where it’s going. So, when it comes to understanding cash flow statements, the key thing to remember is that they’re designed to help you make sense of your other financial documents.
All that said, why should you care about statements of cash flow? Are they really such a big deal? Yes, they are. Here’s why.
Why cash flow statements matter
Cash flow statements matter for many reasons. However, there are a few specific reasons you should know about.
- They help you with financing decisions.
- They show you where you can generate cash more efficiently.
- If you’re struggling to pay debts on time, they might show you where you’re going wrong.
- They show potential investors how well your company operates, and where you can improve.
One final point here: when understanding cash flow statements, it’s important to note that cash flow doesn’t equal profit.
For example, just because you have good cash flow doesn’t mean you’re actually making money. Similarly, you could be profitable but struggling to manage your cash flow. That’s why you need to remember to read your statement of cash flow alongside your other financial statements.
Understanding cash flow statements
So, we’re clear on what a cash flow statement is and why it matters. But how do you interpret your own statement of cash flow? Don’t worry, it’s actually easier than it sounds. Let’s break it down.
Every cash flow statement has three main parts:
- Operating activities
- Investing activities
- Financing activities
Let’s take a look at these three parts in turn.
This section shows you how much cash you’re generating from your goods and services, and how much you’re spending.
First, you’ll see net income. The figure comes from the income statement.
Next you might see depreciation expenses. These expenses reflect how much company assets, such as property, reduce in value over time through wear and tear.
Then, you’ll find your operating activities, such as:
- Accounts payable: money owed to suppliers
- Accounts receivable: money owed to you
- Inventory: if you’ve bought new inventory to sell
So, for example, you might see an increase in accounts receivable from one month to the next. This could mean that you have more cash because you haven’t paid someone yet, or it could simply mean that your business is growing.
Investing activities relate to buying and selling assets, such as land, property, or goods. This section also includes loans you’ve made to vendors.
Examples of activities you’ll find here include:
- Buying new hardware or machinery
- Receiving loan repayments from vendors or customers
- Payments made or received in a merger
- Investments you make
So, if you’ve sold machinery recently, you’ll see an increase in cashflow.
Finally, you’ll see financing activities. Here, you’ll find activities such as:
- Repaying business loans and business credit cards
- Dividend payments
- Raising capital
If you’ve recently borrowed money, you’ll have more cash flow. However, if you’ve repaid a long-term loan, you’ll see a drop in cash.
Closing cash balance
At the bottom of each section, you’ll see the net income generated from those activities. If you want to see the closing cash balance for the period, it’s at the bottom of the statement.
If there’s one skill that every business owner needs, it’s understanding cash flow statements. The good news is that they’re simpler to read than they seem at first glance.
Remember, though, if you’re struggling to make sense of your own cash flow statements, or you need help writing your own statements, you should ask a qualified accountant for advice.
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