Most businesses prepare three primary financial statements — the balance sheet, income (profit and loss) statement, and statement of cash flows. It’s the third of these statements that often provides the most insight into day-to-day operations. Why? The cash flow statement focuses on transactions that may not directly affect a company’s income, expenses, or financial standing at a given point in time.
The balance sheet may help a business owner to identify long-term trends such as declining receivables or increasing debt. But because that information is not directly stated on the balance sheet, it may be obscured, especially by end-of-period accruals. Similarly, some transactions may not show up on the income statement until it’s too late to take action. Such transactions might include equipment purchases and liquidation of long-term debt. To really know where cash is coming from and where it’s going, there’s no substitute for the statement of cash flows.
The cash flow statement provides information about three types of business activities: operations, investments, and financing. The operating section tells you how much cash you’ve received from sales and services, and how much you’ve used to cover payroll, vendor invoices, rent, taxes, and utilities. This section focuses on routine business transactions. The investing section deals with cash flows for capital expenditures (such as equipment and property purchases), as well as purchases and sales related to stocks and other investments. The financing section presents information about cash proceeds from loans, installment payments, and cash transactions with company owners.
By displaying these categories of cash flows, a business owner can tell at a glance the reasons for changes in cash balances from one period to the next. If done correctly, the cash flow statement can help an owner to budget for future periods and identify potential financial problems before they get out of hand. For example, if cash flows from receivables are declining over time, a business owner might want to revamp his or her credit policies or increase collection efforts. If substantial cash outflows are being used to finance obsolete equipment, maybe it’s time to sell off those assets and build up cash balances.
When used in concert with a company’s other financial documents, the cash flow statement can provide insight into a business’s current health and long-term viability. If you’d like help analyzing your company’s cash flow statement, give us a call.