“Our Income Statement shows that we are profitable, but how come our company is definitely strapped for cash? ” This is a common question I get from managers plus business owners alike. And I always tell them that the Cash Flow Statement is one place to look for answers. This financial statement is one of the reports mostly overlooked specifically by small business owners. Most of the time, they are not even aware that this financial statement is one of the basic reports they should be getting off their accountants.
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The Cash Flow Statement shows the actual cash generated by the company for a given period. It is primarily composed of three main categories:
Money generated from or used in procedures
Investments made by the company
Cash Flow from Operations
This type revolves around four activities:
Collections from customers
Payments to providers
Other operating cash outflows such as sales & marketing and administrative expenditures and interest payments
Cash taxes payments
A positive net cash flow through operations means that the company’s core business operations is able to sustain itself : the collections from customers are usually enough to cover the day-to-day needs of the business.
A negative net cash flow from operations means that the cash inflows from the company’s operations are not enough to cover the daily costs plus expenses. This is quite expected with regard to companies who have just recently started functions because efforts are still focused on sales and marketing to build customer foundation. But management should always work to enhance the net cash flow from operations to assure investors that management is effective within controlling the financials and functions of the business.
Cash Flow from Trading Activities
This section usually shows the quantity of cash spent by the company upon capital expenditures, such as new manufacturing plant equipment or business expansions. This section also includes other monetary investments (such as money market funds) and acquisitions of other businesses.
There is a negative net cash flow from financing activities if the company put money into investments during the time period. It is good to see a company re-invest some of its profits back into the business to cover depreciation of its fixed assets and/or to finance business expansion.
Conversely, the net cash flow from financing activities is positive if the firm liquidated or sold some or all of its investments. This may occasionally be required to generate funds to augment the particular operational requirements of the business. Liquidating investments is better compared to borrowing funds from the bank or other creditors because the company will not have to pay interests.
Cash Flow from Financing Activities
It shows the outside financing activities carried out by the company. The cash inflows through financing activities pertain to extra capital from investors or through borrowings from the bank or additional creditors.
The cash outflows from financing activities, on the other hand, result from repayments associated with bank loans and other borrowings and/or cash dividend payments given to investors.
Effective Cash Management
A big part of running a business is managing the funds. You need to make sure that your company’s cash inflows are timely and enough to pay your cash outflows. Your company will be appealing to potential investors when they see that your own over-all operations produce adequate free cash flow (FCF). Free cash flow implies that your company has the ability to pay debts, yield dividends and facilitate the growth of the business.
A regular analysis of the cash flow statement will enable you to determine the particular working capital required by your operations. You will also see if your operations are usually generating enough cash and if you might have extra funds either to broaden your business or in acquiring other opportunities. You will also be timely prompted if you wish to get additional funds either from your investors or creditors.