I was helping a new client close the books for 2012 today. We reviewed her P&L and she wanted to know why her draws didn't show up there. I took her to the Balance Sheet and showed her where the draws were located. She wanted to know if there was a way to look at both the income and expenses on the P&L and the draws as well since they have a big impact on the money in the business' checking account. I introduced her to the Statement of Cash Flows.
The Statement of Cash Flows tells you how money came into your business and how it went out regardless of whether it was a balance sheet item (inventory, accounts receivable, fixed assets, credit cards, bank loans, draws) or a P&L item (sales, advertising, interest, rent, telephone expense).
It is quite possible for a business to be profitable and yet to find itself without any money in the bank and the Statement of Cash Flows can show the owner why. There may be too much debt and the loan payments may be eating up all the profits. The business may give its customers more time to pay that its suppliers give the business so the money is going out faster than it is coming in. Studying the statement give give an owner the answers she needs to fix the cash flow woes. She may need to renegotiate terms with her suppliers or shorten the terms she gives her customers. She may need to refinance her debt to have a longer term and lower payments.
My client was excited to have someone explain how cash flow works. She looks at her financial statements frequently but she had never been shown the Statement of Cash Flows. Now she has a better idea of what to look at when she is determining the size of her next draw.
Stayed tuned next week for greater detail on the Statement of Cash Flows!