We have discussed the Balance Sheet and the Profit & Loss Statement so today we will address the Statement of Cash Flows. This financial statement is the most complete because it encompasses everything that happens in a business. The Balance Sheet deals with assets and liabilities and only gives the net profit activity. The Profit & Loss Statement only deals with revenue and expenses and ignores all activities involving assets and liabilities. The Statement of Cash Flows details exactly how money came into a business and how it left, whether this was by earning it, collecting it, borrowing it or spending it.
The Statement of Cash Flows starts with your net profit or loss for the period you are examining and then adjusts for any expenses which were not truly cash expenses such as depreciation. It then goes on to look at other ways the business spends money or bring money in. If you borrowed money from the bank, that improves your cash flow as you now have brought cash into the business which can be used to buy equipment, buy inventory or pay for expenses. If you use a credit card or get terms from a supplier, the same thing happens: you get products or services for your business which you didn’t have to pay cash for. So as far as cash flow is concerned, increasing your debt is a good thing. There is one exception: loan payments are a reduction of cash flow.
The next thing the Statement of Cash Flow considers is the other ways money leaves the business besides normal operating expenses. If you are a sole proprietor or an LLC, your owner or member draws are a use of cash. Draws don’t show up on the Profit & Loss so business owners sometimes wonder why they made a profit but have no money in the bank? The answer is Cash Flow. Other ways money leaves a business besides loan payments and owner draws: Increasing your inventory levels, purchasing fixed assets or paying down your credit cards or loan balances.
Understanding cash flow is very important to running a successful small business. There have been many cases where a business is successful as far as generating sales, but fails because it doesn’t generate enough cash flow to keep going.