So what does the Statement of Cash Flows look like? It starts out with the net income for a business. Obviously, if the business is making a profit, it helps the cash flow! Next, the statement accounts for changes in the balance sheet accounts. This is called the Cash from Operating Activities section and is where many people gets confused as they tend to think of increases in assets as a good thing. Generally this is true, but it does have an impact on cash flow.
If your accounts receivable have increased from the beginning of the period to the next, this means you have earned income, but you haven't collected it yet. You incurred the expenses to generate the income, but you haven't collected the actual cash yet. Increased in inventory are a little easier to imagine as it cost the business money to purchase the inventory and while it is sitting on your shelves, it is not bringing cash into the business. Shortening the terms your offer your customers brings in cash faster as does turning over your inventory more quickly.
On the liability side, the opposite holds true: increases in liabilities generally means improved cash flow. This is because the business has received goods or services it needs to run but hasn't had to paid cash for them yet. Receiving longer payment terms from your suppliers or vendors is one way a business can look to improve it's cash flow.
The net change in assets and liabilities related to operations either increases or decreases cash flow during the period.
Next the business looks at investing activities. The accounting world considers purchases of fixed assets as investments in the business, thus your will see increases in fixed assets in this part of the Statement of Cash Flows. While every business needs certain fixed assets to operate, buying them does eat up cash flow and an owner always considers this when deciding whether to purchase new equipment or vehicles or furnishings.
Principal payments for loans or new loans will also show up in the financing area. A new loan will bring cash into a business while payments eat up cash. Owner contributions and draws are also accounted for in the financing activities area of the statement. The amount an owner draws from a business has a big impact on the cash flow. Balancing personal needs with business needs is something every small business owner needs to consider.
At the end of the statement, the net change in cash is calculated. This can show how a profitable business is running short of cash or how a business suffering a loss can still be in business. Studying the different pieces of the Statement of Cash Flows is a good way to figure out how to improve your small business.
Monday, January 14, 2013
Statement of Cash Flows, Part 2
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