Cash flow in your business is like the waves of an ocean, with revenue washing in and payments for expenses flowing out. A picture of cash flow is not easy to capture because the ebb and flow of money in your business is constantly changing. Still, you need a handle on your cash flow so you can discern trends in cash management and keep your company solvent.
Importance of the Cash Flow Statement
A company may have revenues and appear profitable, but slow collections of invoiced sales can impede its ability to meet its current financial obligations. Delinquencies in payments to employees, vendors and other creditors can grow to the point of putting the company out of business. To get a picture of your cash flow over a specified period of time, create a cash flow statement.
A look back over a specific period of time (typically a quarter) enables you to look forward for the next period to ensure you have the funds on hand to pay your bills.
Creating a Picture of Cash Flow
The cash flow statement shows changes in your cash on hand (including funds in your bank account and short-term investments that you can easily convert to cash). The cash flow statement reflects the activities of a business:
- Operating activities: Inflow from operating activities includes revenue from selling products and/or services, interest and dividends that the business receives, and other cash receipts. Outflow from operating activities includes payroll costs (i.e. wages, benefits and employment taxes), payments to suppliers and vendors, overhead costs (i.e. rent, utilities, insurance, etc.), income taxes and other taxes of the business, and other operations-related cash payments.
- Investing activities: Inflow from investment activities includes sales of business assets other than inventory, payments received from loans that the business made, and other sales that are not in the normal course of business. Outflow includes purchases of capital equipment and loans that the company makes.
- Financing activities: Inflow reflects money that’s borrowed and the proceeds from the sale of the company’s securities. Outflow shows debt service and dividend payments.
There are two ways of creating a cash flow statement:
- Direct method: This tracks specific actions of inflows and outflows from operating activities. Essentially, this method merely subtracts money spent from money received.
- Indirect method: This method is more complicated. It starts with net income and factors in depreciation.
The method you choose depends on the information you need from your cash flow statement.
Creating Your Cash Flow Statement
To create a cash flow statement manually, review your income and expenses in each of the three categories discussed above. Use a self-created spreadsheet or template to organize your data into a cash flow statement (you can download a free cash flow statement template here). Essentially, your entries show cash in and cash paid out each month for the period of your cash flow statement (e.g. a year).
Even easier, you can create a cash flow statement based on a sound accounting system, such as QuickBooks. Having recorded your income and expenses on a regular basis, your accounting software has the information needed to automatically generate a cash flow statement without the need to input each item of income or expense from your business activities.
Reviewing and Projecting Cash Flow
Looking back over the quarter is helpful in knowing where your money went and seeing trends in your business activities. Just as important is looking ahead to make sure you’ll have the funds on hand to meet upcoming obligations. What are your upcoming expenses? What do you project your future revenue to be? Again, look ahead for a specific period, such as the next quarter or the next year, and use the information in your books to generate your projections.
The projections help you decide actions to take, such as cutting expenses if too much money is going out compared with revenue coming in, or seeking a short-term infusion of capital if cash on hand isn’t enough to pay upcoming bills. Once again, it’s up to you to monitor your projections and review your business activities so you can make adjustments accordingly.
Cash is essential for keeping your company afloat. Make sure you have a good understanding of where your money comes from and when, as well as where your money is spent so you can meet your financial obligations. Use a cash flow statement as well as cash flow projections to clarify your company’s position on cash. If you have any concerns about creating or understanding your cash flow statement and projections, work with a CPA or other knowledgeable financial specialist.
Download a free cash flow statement template to get started. Or check out our guide to financial reporting to learn more about essential financial statements, including the balance sheet and income statement.