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oes your business have enough cash to pay its expenses for the next few weeks or months? What about your owner’s draw or salary?

If you’re unsure, it might be time to analyze or create your cash flow statements. Doing so will help you understand your cash inflows and outflows in order to make crucial business decisions.For instance, if you don’t have enough liquid cash (even if you’re profitable), it might be hard to pay the bills, potentially ruining your business’ health.

With that in mind, let’s dig deeper into what you should know about cash flow statements.

Understanding cash flow

In a nutshell, a cash flow statement is a financial statement that looks at the amount of money you’ve got coming in and going out. Business owners can look at these inflows and outflows over a predetermined time period. This financial statement helps businesses see how well they’re managing their cash by looking at whether enough cash is being generated to fund operating expenses and ongoing debt obligations.

Positive cash flow indicates that a company's liquid assets are increasing, enabling it to settle debts, reinvest in its business, return money to shareholders, pay expenses, and provide a buffer against future financial challenges. Negative cash flow, on the other hand, indicates that a company's liquid assets are decreasing. 

Importance of cash flow for small businesses

Having an up-to-date cash flow statement is important for analyzing the financial health of your business. It can help you predict how much cash will be left at the end of every month and ensure you have enough on hand to keep operations running smoothly. If there isn’t cash, businesses may need to dip into savings or take out a loan. However, if your business consistently generates more money than is going out, you may be able to take more risks and use some cash to fund business growth.

A cash flow statement is also important if you’re looking for outside investors for your small business. Investors will want to determine whether your business can earn money and pay back obligations. The healthier your business is from a cash flow perspective, the more interested investors will be in your business.

Types of cash flow

There are three primary types of cash flow:

  • Operating cash flow: The cash generated from a company's core business operations
  • Investing cash flow: The cash a company spends or earns from investments
  • Financing cash flow: The cash used for funding the business

Components of a cash flow statement

A cash flow statement is generally divided into three components: cash from operating activities, cash from investment activities, and cash from financing activities.   

Operating activities

This section will include how you earn and use cash from your business activities. Cash inflows in the operating activities section can come from:

  • Sales of goods or services
  • Interest received
  • Dividend income

Cash outflows in the operating activities section can result from:

  • Payments to suppliers and employees
  • Interest payments
  • Payments for taxes

Investing activities

Investing activities include any sources and uses of cash from a company's investments.

Cash inflows from investing activities could come from:

  • Sale of property, plant, and equipment
  • Sale of investment securities
  • Collection of principal on loans to other entities

Cash outflows for investing activities may include:

  • Purchase of property, plant, and equipment
  • Purchase of investment securities
  • Loans made to other entities

Financing activities

Here, you’ll include sources of cash from banks or investors. You’ll also need to include any cash you pay back to investors.

Cash inflows from financing activities include:

  • Proceeds from issuing stock
  • Borrowing from lenders through formal loan agreements, bonds payable, etc.

Cash outflows in financing activities may result from:

  • Repayment of principal amounts borrowed
  • Purchase of the company's own stock
  • Dividends paid

Creating a cash flow statement

Preparing a cash flow statement will help you better understand your company’s value and health and help you make more informed decisions. Here's how to write a cash flow statement.

Methods for preparing a cash flow statement

The two methods of calculating cash flow are the direct and indirect methods. The direct method takes into consideration all cash inflows and outflows — think receipts from customers and money paid to suppliers and employees. You’ll arrive at a final calculation by looking at the beginning and ending balances from your business accounts, then analyzing the net increase or decrease.

The indirect method of preparing a cash flow statement involves starting with the business's net income, which is derived from the profit and loss statement (also known as the income statement). However, since the profit and loss statement follows the accrual accounting method, it may not accurately reflect cash flow. Therefore, adjustments need to be made to the net income figure, specifically for items that impact net income but do not directly affect cash flow, as well as non-operating activities. For instance, depreciation, which represents the decrease in value of assets like equipment, is not considered a cash expense. As a result, it is added back to the net income since its impact has already been accounted for.

Example of a cash flow statement

Let's walk through an example of a simple cash flow statement prepared using the indirect method:

Operating activities:

  • Net income: $50,000
  • Adjustments for non-cash items:
  • Depreciation: $5,000
  • Changes in working capital:
  • Decrease in accounts receivable: $3,000
  • Increase in accounts payable: $2,000
  • Total cash provided by operating activities: $60,000

Investing activities:

  • Purchase of equipment: -$20,000
  • Sale of investment securities: $10,000
  • Total cash used in investing activities: -$10,000

Financing activities:

  • Proceeds from issuing stock: $15,000
  • Dividends paid: -$5,000
  • Total cash provided by financing activities: $10,000

Net increase in cash

$60,000 (from operations) - $10,000 (from investments) + $10,000 (from financing) = $60,000

The cash flow statement provides a clear picture of how the company is generating and using its cash. In this example, the company has a net increase in cash of $60,000 during the period.

Analyzing a cash flow statement

You'll learn a lot of valuable data about your company’s financial health if you know how to read cash flow statements

Interpreting cash flow data

A positive cash flow from operating activities indicates that the company is generating sufficient cash from its main business operations. Strong investing activities demonstrate long-term future development, while financing activities can tell you if your company is over-leveraged.

Understanding the relationship between cash flow and business performance

A company's cash flow can reveal a lot about its financial health. A company might be profitable on paper, but if it's not generating positive cash flow from its operations, it may not be able to sustain its business in the long term. Heavy investing activities could mean the company is gearing up for growth, but if this continues for too long without a corresponding increase in cash flow from operations, it could signal problems.

Regular issuance of debt might indicate a company is struggling to generate enough cash, while regular payments of dividends could indicate strong cash flow and profits.

Using cash flow statements to make informed business decisions

You can use a cash flow statement to evaluate a business's financial health in the following ways:

  • Evaluate solvency by assessing whether a company generates enough cash to keep the business running
  • Assess investment and growth potential by seeing how aggressively a company is investing in its future growth
  • Understand financing structure through how a company raises capital, manages its debts, and returns profits to shareholders
  • Benchmark performance by comparing a company's cash flow statement to those of similar companies

Common cash flow issues

Cash flow problems can arise from various causes. Low profit margins, resulting from high production costs, overstaffing, or pricing products or services too low, can lead to financial difficulties. Inconsistent sales, including seasonal fluctuations or unexpected drop offs, can also disrupt cash flow. Late payments from customers can further compound the problem as the business awaits reimbursement for already incurred costs.

High overhead costs, such as rent or utilities, can strain cash flow, while unexpected expenses like emergency repairs, legal issues, or the need for new equipment can also have a negative impact. Lastly, even profitable businesses can face cash flow issues if they lack effective cash flow management, including accurate tracking of income and expenses and failure to forecast future cash flow.

You can address cash flow issues by:

  • Negotiating improved payment terms with suppliers
  • Encouraging timely customer payments through discounts or incentives
  • Working to increase sales by expanding marketing efforts, entering new markets, or adjusting prices
  • Implementing cost reduction measures, such as minimizing overhead costs, trimming non-essential expenses, and renegotiating supplier contracts

Tools for managing cash flow

You can choose from many available tools to help manage cash flow.

Accounting software

Accounting software is designed to manage and track financial transactions within an organization. Examples of accounting software include QuickBooks, Xero, and FreshBooks. If you have a Novo checking account, Novo integrates with many popular accounting tools so you can see all your transactions within the Novo platform.

Cash flow forecasting tools

Cash flow forecasting tools help you predict your future financial position, which can aid in avoiding potential cash flow problems. Examples include:

  • Float
  • Pulse
  • Futrli

Budgeting tools

Budgeting tools assist with planning and controlling income and expenses. Examples include:

  • Mint
  • YNAB
  • PlanGuru

Best practices for cash flow management

Cash flow management is an ongoing process that requires regular attention and adjustments. Monitoring cash flow regularly lets you identify trends, prepare for future costs, and detect potential problems early. You should create a cash flow statement at least quarterly. Using Novo’s business checking account can make it easier to track your cash inflows and outflows.

Final thoughts

Creating a cash flow statement is a valuable use of your time since it helps you measure your business's long-term outlook, strength, and profitability. It will show you whether your business has enough cash to meet its financial obligations and help you predict future cash flow. Analyzing these statements closely over a period of time will give you a more solid understanding of your business's health and whether you can afford to invest in its growth.

Novo Platform Inc. strives to provide accurate information but cannot guarantee that this content is correct, complete, or up-to-date. This page is for informational purposes only and is not financial or legal advice nor an endorsement of any third-party products or services. All products and services are presented without warranty. Novo Platform Inc. does not provide any financial or legal advice, and you should consult your own financial, legal, or tax advisors.

Novo is a fintech, not a bank. Banking services provided by Middlesex Federal Savings, F.A.: Member FDIC.

May 29, 2023
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