Understanding and Using Your Cash Flow Statement

Author: Rieva Lesonsky | October 22, 2016

What is a cash flow statement and why is it so important?

A cash flow statement is part of your business’s financial statements, which include these:

  • An income statement
  • A balance sheet
  • A cash flow statement

However, a cash flow statement isn’t just something you prepare and put in a drawer to never look at again. Used correctly, it can be a vital tool for managing your business and planning ahead for financing needs. Here’s how it works.

Elements of the Cash Flow Statement

The cash flow statement measures your business’s financial activity over a period of time. It can be used to track the cash flowing into and out of your business, similar to a checkbook register for your personal bank account. However, it’s a little more complex than a checkbook register. The cash flow statement includes four categories:

  1. Cash flow from operating activities
    This includes cash received from customers as well as interest received from any investments your business makes. It also includes cash paid out—to suppliers, employees, or for other operating expenses—as well as any interest and taxes paid during the period.
  2. Cash flow from investing activities
    This includes investments in equipment, property, or real estate; sale of those assets; changes in the value of assets; and other investing activities such as buying securities.
  3. Cash flow from financing activities
    This includes any increase or decrease in short- or long-term loans (in other words, if you’ve taken out a new loan or made payments on an existing loan), dividends paid, or sales of stock in the business.
  4. Increase or decrease in cash
    By adding up all the income and outflow from these three types of activities, you’ll come up with a net increase or decrease in cash available to your business—that is, a positive or negative cash flow.

Using the Cash Flow Statement

Ideally, you want to maintain a positive cash flow at all times. This ensures you have the funds available that you need to pay your bills, pay employees, and purchase inventory or assets in a timely fashion. In reality, of course, many businesses find that from time to time, their cash flow is negative. Or perhaps it’s an ongoing problem: You are doing fine on paper in terms of profitability, but somehow find that you frequently run short of cash.

Reviewing your cash flow statement regularly can help you spot this type of cyclical pattern in your business and prevent a cash flow emergency. For example, if your cash flow tends to veer towards the negative territory at the end of each month, that’s an indication that you need to bring in more money at that point. Perhaps you need to accelerate your collections efforts, bill customers earlier in the month, decrease expenses at the end of the month by talking to vendors about longer payment terms, or use invoice financing to meet your cash flow needs.

You should review your cash flow statement at least quarterly; however, it’s a good idea to do so monthly to really stay on top of things. Depending on your industry and your financial situation, you may even want to keep tabs on your cash flow statement on a weekly or daily basis.

If you use accounting software, it’s a simple matter to set up monthly cash flow statements. As long as you are regularly recording your income and expenses in your accounting system, the software can easily generate a cash flow statement for you. Once you’ve gotten a handle on your current cash flow, you can look ahead by creating a cash flow forecast.

By regularly reviewing your cash flow statement, you’ll have a better handle on your business’s finances and be able to plan ahead for financing needs so you’re never caught short of funds.

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