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Teaching Financials to Drive Performance: Part 3, The Cash Flow Statement

Every business owner wants to increase cash flow to have more cash. But it’s frustrating trying to figure out which “levers” to pull to increase cash flow. It shouldn’t be so hard to have a business that brings in more cash than it spends.

Recent studies show that the lack of cash flow is the one issue business owners take home with them and 54% state this issue alone keeps them awake at night.

About 8 years ago, I had a client that was in the middle of a turnaround and had a spectacular year. They made $500,000 in net profit after a $250,000 loss the year before. But when he looked at his cash flow statement he said, “Why is my cash account only up $50,000? I made $500,000 in profit last year.” I told him to look at his balance sheet and see that his accounts receivable was up $450,000 and the remainder of his profit was sitting there. The light bulb went on!

As a business owner, you understand that profit doesn’t cover payroll or loan payments or any other expense. Cash does. But what exactly is the difference between cash flow and profit?

Profit is what the company has earned, revenue minus expenses (reflected on the income statement). Cash flow is the amount of cash coming into your business minus the amount of cash going out of the business. If the difference is positive, you have positive cash flow. If the difference is negative, then you have negative cash flow. The way you determine whether cash flow is positive, or negative, is with the cash flow statement.

It’s divided into 3 parts:

Operating Activities– Operating activities include revenue, cost of goods sold, and operating expenses. But it also includes any increases or decreases in receivables, inventory, and payables. Because profit is included in operating activities, most businesses have positive cash flow after operations.

So, what did you do with that positive cash flow after operations? You may have done one of two things:

Investing Activities– Investing activities are any changes in fixed assets (bought or sold), any interest expense, or any dividends or withdrawals. If you paid cash for fixed assets or made significant distributions, those items are subtracted from cash flow from operations and at this point, cash flow could be positive or possibly negative.

Financing activities– Financing activities include any changes in short-term or long-term debt, or any additional capital you put in the business in the form of paid-in capital or common stock. If you borrowed money to finance those long-term assets you purchased, that provided the cash to cover the fixed assets mentioned in investing activities.

The sum total of all these cash inflows and cash outflows reconciles to the changes in cash from the beginning of the accounting period to the end of it on the balance sheet (month, quarter or year).

The best way to avoid confusion between cash flow and profit is to think like a business owner instead of an accountant.

A business owner thinks in terms of cash flow, not profit. They look at revenue when it’s collected and look at expenses when they have to pay bills. If they run out of money, they either borrow on their line of credit or put money in themselves.

If you use Quickbooks, go to reports, then click either statement of cash flows or cash flow statement and choose the accounting period you’re interested in (month, quarter, year). This will show what your cash flow looked like for the given period. You can begin analyzing and understanding exactly where your money is going and if any changes need to be made.

P.S. The cash flow statement is the most confusing of the 3 financial reports. If you’d like help interpreting it, let’s talk today.

If your cash outflows are greater than your cash inflows, it may be time for a deep dive into your financials to check for blind spots that may be costing you money.

Cheers to lots of positive cash flow in 2021!

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