Why Your Business Needs a Cash Flow Statement (and How to Understand It)

As a business owner, you’re constantly juggling numbers. You know sales are up, but is there cash in the bank?

That’s where the cash flow statement comes in. It’s not just for accountants; it’s a vital tool that gives you a clear picture of how cash moves in and out of your business.

What’s the Big Deal About Cash Flow?

Think of cash as the lifeblood of your business. Paper profit is great, but you can’t pay bills, invest in growth, or even cover payroll without actual cash. A cash flow statement tells you:

• Where does your cash come from: Net income generated from operating activities, loans, or investments?
• Where does your cash go: Equipment and debt payments?
• Your overall cash position: Are you gaining or losing cash?

Why Should You, as a Business Owner, Care?

• Avoid Cash Crises: Predict potential shortages and take proactive measures.
• Make Informed Decisions: Understand if you can afford new equipment, hire staff, or expand.
• Improve Financial Planning: Create realistic budgets and forecasts.
• Attract Investors/Lenders: Show a healthy cash flow to secure funding.
• Understand Profit vs. Cash: Profit doesn’t always equal cash. You might have sales, but when do you collect?
• Understand where your cash is: Who are you paying and collecting from? Do you have a sound fiscal relationship with your customers and suppliers? If you have higher accounts receivable or payable, that indicates slow cash flow. Ensure that A/P and A/R keep moving, as you do not want to get stuck regarding payments and collections.  

Breaking Down the Cash Flow Statement

The cash flow statement is divided into three key sections:

1. Operating Activities: Cash generated from your core business operations.  It starts with net income.
2. Investing Activities: Cash spent on or received from long-term assets (like equipment).
3. Financing Activities: Cash from debt, equity, and dividends.

The “Operating Activities” section has two methods for calculating cash flow. Here at KATA, we use only one, the indirect method.

• The Indirect Method:

• This method starts with your net income from the income statement and adjusts it for non-cash items and changes in working capital (like accounts receivable and inventory).
• It’s the most common method, as it’s easier to prepare from existing financial records.

The Indirect Method – Operating Activities

Net Income	$-
Add back: Non-Cash Items
Depreciation/Amortization	$-
Add Changes in Working Capital:
(Increase)/Decrease in A/R	$-
(Increase)/Decrease in Inventory	$-
(Increase)/Decrease in Prepaid Expenses	$-
Increase/(Decrease) in A/P	$-
Increase/(Decrease) in Accrued Liabilities	$-
Increase/(Decrease) in Taxes Payable	$-
Increase/(Decrease) in Deferred Revenue	$-

Key Takeaway:

The goal is to understand how much cash your business generates. Don’t let the technical terms intimidate you. Focus on the big picture:

• Is your cash flow positive or negative?
• Where is your cash coming from, and where is it going?

Understanding your cash flow statement will give you valuable insights into your business’s financial health. This will allow you to make smarter decisions and build a more stable and profitable future.