As a business owner, you shouldn’t have to be an expert in bookkeeping to understand your financial statements (but hey, you can if you want to be!). You should be able to use them to make well-informed business decisions, though. In this post, we’ll show you how to read a Statement of Cash Flows, including:
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The Statement of Cash Flows is a reconciliation of the information on your Profit & Loss Statement and Balance Sheet. It’s a summary of all the transactions that move cash into and out of your business’ bank accounts.
Here’s a sample Cash Flow Statement that we’ll reference later on:
To build this statement, bookkeepers (or software) take the net income listed on your Profit & Loss Report and adjust it, so the new number reflects the actual cash that changed hands. The Cash Flow Statement is also where fundraising, selling shares, and interest earnings on investments gets reported.
This statement takes all that information and offers you a different perspective than the other reports can give. It enables you to reconcile and confirm that the numbers in your bank account actually match up with your financial activities. At the same time, it gives you an idea of the company’s cash position — by taking out transactions that haven’t actually happened yet (like credit card spending, accounts payable, accounts receivable) and representing all types of income (like income from shares).
Depending on your business expenses and income, your Cash Flow Statement will vary in depth and complexity. But the five main components of the statement are always constant. They include:
Let’s look at what goes into each of those categories and what it represents for your business.
Even if you don’t spend a lot of time analyzing financial statements, net income is a number most business owners are familiar with. It represents your net earnings after your expenses have been deducted from total sales. You might also call it “profit” or your “bottom line.”
Net income is where every Statement of Cash Flows starts, and it comes directly from your Income Statement (also known as Profit & Loss Report). If you use accrual accounting (as many businesses do), your net income will take non-cash transactions into account. That means it won’t match up with how much cash is actually in your bank account. It often includes:
The Cash Flow Statement goes on to make adjustments to net income — so your net cash (or final cash value) matches your bank account.
The first section of the Cash Flow Statement represents cash transactions that have to do with regular operating activities of your business — the cash you spend and receive as a result of doing what your business does every day. The cash flow statement adjusts your net income based on transactions that had cash movement in the month. Some examples include:
In short, the net cash flow from operating activities represents the difference between the cash you received from customers and the cash you paid out for operating expenses. For many businesses, this is the most important and useful portion of the Cash Flow Statement because it tells you how everyday operations affect the amount of cash you have on hand.
Based on the example statement above, you made a prepayment of $5,000, which reduces your cash flow. You charged $10,000 on your credit card, you accrued an expense of $7,000, and you had accrued payroll of $20,000 all of which increases your cash flow. When combined with your net income, you end up with an operating cash flow of $532,000.
The next category catalogs changes to your cash from investing activities (otherwise known as capital expenditures). It’s important to note: this section of the Statement of Cash Flows is concerned with the investing your business does—not what others invest in you (that comes next, in the financing section).
Investing activities can include cash inflows and outflows resulting from:
Security deposits for an office space (like in the example above) are considered investing cash flow because they represent an investment in the business and its future growth.
Together, these investments and earnings represent your net cash flows from investing activities.
The third category of transactions on your Statement of Cash Flows is financing activities, and it deals with cash involved with borrowing, repaying, or raising capital. This is where investments others have made in your business are recorded, and that may include:
This section of the statement culminates in your net cash flows from financing activities.
For example, if you raised $500,000 in venture capital funding and paid out $40,000 in dividends to shareholders, your net cash flows from financing would be +$460,000.
The Statement of Cash Flows represents changes to cash over a set period of time (often a month, quarter, or year). This final portion of the statement combines all the previous sections (including net income) and represents the true cash value in your business accounts at the end of that period. This balance can either be a positive or negative value.
Now that you have a better idea of what the sections and transactions on your Statement of Cash Flows represent, it’s time to interpret them. Here, we’ll talk about four big questions you might ask about your Cash Flow Statement.
Whether you call it “net cash flow” or “net cash increase/decrease for the period,” there are several reasons your company’s net cash flow may be negative.
Since net cash flow is an indicator of the change in cash over a period of time (and it doesn’t include existing cash), a net cash decrease doesn’t necessarily mean you won’t have enough cash to cover the bills.
For example, your business could be performing very well, so you have decided to invest heavily in growth right now. That would cause your cash flow to be negative at the moment, but wouldn’t indicate an area of concern because you know your business is healthy and growing.
While negative cash flow isn’t always a cause for concern, it can be when it persists over several periods because each period depletes the cash balance you have available to spend.
Negative or tight cash flow is often more about timing than anything else. One option to increase your business cash flow is to reduce payment terms for customers, so less time passes between when you earn income and when you actually get paid. Aside from that, a review of your operating expenses and investments can also be beneficial in managing cash flow.
One way to grow your business is to take your income and leverage that cash to invest further in your business. That could include hiring more employees, buying better equipment, or expanding your marketing efforts.
If you don’t reinvest profits back into growing your business, growth could come at a slower rate. That could work well for your business model, but for some companies, like high-growth startups, it would be cause for concern.
If you start to notice a pattern of particularly large positive cash flow, ask yourself if there’s anything you would like to do to reinvest that cash and turn it into future growth.
Many business owners aren’t accounting experts. That’s okay — you can hire someone else for that. But understanding key financial statements means you can use them to get a complete picture of your business’ financial performance and make the best decisions to help it grow. Hopefully, this guide to understanding your Statement of Cash Flows helps you in that process.
Want someone to hand you accurate, organized financial statements each month? At Pilot, we offer one of the best bookkeeping services around. Try one.