Everything You Need to Know About Cash Flow Statements
As a business owner, financial statements might be the last thing on your mind. After all, it’s easy to outsource routine accounting functions so you can focus your efforts on growing your business. Still, it’s important to understand and appreciate your financial position to steer your business in the right direction.
When running a small business, the cash flow statement is one of the most relevant snapshots of your company’s financial situation at any point in time. It tracks the money moving in and out of your business each month and shows whether you’re solvent or at risk of overdrawing your account. This is critical, since 82 percent of small businesses fail due to cash flow problems.
Fortunately, we’ve compiled an easy guide to help you avoid this common small business mistake.
How Small Business Owners Can Utilize Cash Flow Statements:
What is a Cash Flow Statement?
A cash flow statement shows the changes to your business checking account as a result of your business activities. For example, cash increases when a customer pays a bill or decreases when you pay off your business’s credit card balance.
Depending on how frequently you track cash flow — daily, weekly, or monthly — the cash flow statement can help you identify surpluses or shortages in real time. Having this information at your fingertips helps you understand whether you need to cut expenses or earn more to stay cash positive.
How to Calculate Cash Flow
There are various definitions of cash flow, which impact how it’s calculated. Broadly speaking, the cash flow statement identifies all sources and uses of cash to determine the amount left over after you pay your operating expenses and capital expenditures.
Free Cash Flow = Operating Cash Flow – Capital Expenditures
Operating cash flow is the cash generated from normal business operations. It measures inflows and outflows related to your primary business activities. Capital expenditures are payments your business makes to acquire, upgrade, and maintain physical assets, such as property and equipment.
How to Interpret Free Cash Flow
Free cash flow is a transparent measure of your business’s potential to make money. While at times free cash flow may be negative because you run a seasonal business or customers are late making payments, if you’re consistently losing cash it may be a sign that you need to change your business model or make better management decisions. On the other hand, if you’re routinely generating positive free cash flow, you can pursue new strategies to improve and expand. Importantly, growing free cash flow month after month is often viewed as a prelude to increased profitability.
Why You Need a Cash Flow Statement
In a broad sense, the cash flow statement is an accurate reflection of your company’s financial position and performance over time. While an income statement is important for tracking sales and the balance sheet shows accounts payable and receivable, these measures don’t affect your bank account until cash flows in or out of the company. The cash flow statement, therefore, provides context for your other financial statements and is often more helpful for day-to-day decision-making.
In addition, understanding free cash flow helps you make more prudent long-term business decisions. For example, if you anticipate negative free cash flow for a period, you might decide to take out a short-term working capital loan to keep the business afloat until positive cash flow resumes.
Conversely, if you’re consistently generating positive free cash flow, you can pursue new ventures or expansion projects to make your business more profitable.
Lastly, you might want to pursue outside capital at some point to grow your business. Creditors and investors want to know they’ll get their money back. Your cash flow statement is proof that your business generates real money and you can afford to pay back your debts or earn a positive return for your investors if they back you.
Conclusion: Don’t Overlook the Cash Flow Statement
When your business is new, it’s easy to get away with back-of-the-envelope calculations and gut decisions. However, to implement informed and effective business strategies, you’ll need a comprehensive picture of your company’s financial situation. A cash flow statement can help you better understand where your business is now and where it needs to be.