Once your business runs out of cash, you will find that you have opened up a pandora’s box worth of financial misery on your organisation. Suddenly your employees look lethargic and suppliers stop shipping important inventory to you.
You know what’s even more surprising? You might be actually facing all these problems, when in reality your business is actually making a profit.
Many small business owners have been vexed by this particular conundrum, where they are seeing great profits on paper, but have no cash on hand. It sometimes takes a while to realise that a cash flow statement is perhaps as or even more important than profit/loss statements.
What is a Cash Flow Statement?
A cash flow statement is also commonly referred to as a ‘flow of funds’ statement and in effect it showcases your firm’s liquidity.
A cash flow statement acts as a summary of your firm’s obligations and financial resources at any given point in time. The income statement on the other hand provides a snapshot of all the transactions involving your firm in a particular period of time.
Both these statements are used to analyse the revenues generated by a firm and compare it with the expenses involved in bringing in that revenue.
This statement is based on the outflow and inflow of cash (or cash equivalents) within an organisation. However, transactions that don’t directly involve/affect cash payments or receipts are excluded from a cash flow statement. Examples of these include depreciation of asset value, credit losses or writing off bad debts.
The main objective of a cash flow statement is to:
- Give greater information about a business’s solvency and liquidity and its ability to alter cash flows in future scenarios.
- Provide extra information related to depreciating value of assets, equity and other liabilities.
- To showcase the timing, probability and amount of any/all future cash flows.
So, how important is a cash flow statement for your business? Let’s find out.
A cash flow statement will basically tell you where all your money went
A profit and loss statement will not shed any light on all the principal payments that you make to your lender. The amount you pay back to your lender each month might be putting you in the red even though your business is generating sufficient profits.
With a cash flow statement you will know exactly where the money was spent. For example, if you had to purchase increased inventory or equipment, you would have needed cash. Or if you wished to extend credit to your regular customers/clients, your would have used cash.
None of these transactions will turn up on a profit loss statement, which makes a cash flow statement an absolute necessity.
A cash flow statement can help you devise ways to create more cash
It goes without saying that profitability is the absolute end goal for any small business. Profits generate greater revenue or cash for your business.
But, there are other ways to improve the cash flow of your business.
If you can figure out ways to reduce your payments on capital equipment, you are in essence generating more cash even as your spending it. You can increase your cash reserves by collecting receivables from your customers/clients before it becomes overdue.
If you focus just on the profitability of your business, you might take your eye of the ball with respect to your business’s cash flow which might lead to bigger issues down the line.
Cash flow statements can help you provide better Key Performance Indicators (KPI’s).
Generating greater cash reserves for your business should be considered as a KPI. This can affect almost every important aspect of your business.
If you are able to figure out ways to boost your business’s cash reserves, it will also help you to create better business value. Businesses that prioritise the creation of stronger cash reserves have historically fared better in terms of generating enterprise value compared to businesses that are solely focussed generating profits.
Generating cash flow statements will also help you take more sound financial decisions. The bottom line is you will need cash to:
- Buy capital equipment
- Increase Inventory
- Increase your capacity or
- Add customers
The question you should not be asking yourself is whether you will need cash to grow your business (you will!), instead you need to be asking yourself how you are going to finance your business growth?
Sometimes you can use cash from your profitable income. Sometimes you can borrow from a bank. Sometimes you will have to seek cash flow finance. Don’t know how cash flow finance works? Click on the link to find out more.
By being aware of where your business is spending its cash and how you can generate greater cash reserves when you need it, you will be able to run your business in a more efficient manner, which increases your chances of being successful over the long term.