Today we’re going to move away from talking about profit and focus on cashflow.
The five gold rings challenge is to find the cash flow statement, sometimes called the cash summary, in your accounting system or software.
The cash flow statement records the flows of cash in and out of a business. Like the profit and loss, it records the flow over a period of time – a week, month, quarter or year.
The irony of the cash flow statement is that it is the most useful of the three financial statements but is the only one that accountants rarely include in the accounts they prepare for their clients.
The other distinguishing feature of the cash flow statement is that it is, also, the only one of the three statements that is based on fact, rather than estimates and assumptions.
The cash flow statement is divided into three sections:
- Operating cash flow;
- Financing cash flow; and
- Investing cash flow.
The most useful of these is the operating cash flow statement as this records whether net cash has flowed into or out of a business over a period of time and determines whether the business is solvent and for how long it will remain so.
The metric of net operating cash flow and its trend over various data points is probably the most useful number for you to know. If net operating cash flow is positive then the business will be accumulating cash for distribution to its owners or for future investment. The business is solvent and healthy.
If operating cash flow is negative this represents a warning sign and if it remains negative for any length of time, then the warning rises to critical. The business is running out of cash. A simple calculation to compare ‘cash burn’, the weekly or monthly negative operating cash flow, with cash reserves will tell you how soon cash will run out if the reserves are not topped up.
What is important for business owners to understand is that operating cash flow can be negative even if the business is showing a profit.
A question I am quite often asked by business owners is “My accounts show a profit but I’ve got no cash in the bank; where is it?”
The answer is always to be found in the cash flow statement. A reconciliation between profit earned and cash flow during a period should be simple to prepare and should, really, be on every business owners’ agenda for their monthly review of their accounts. The usual items making up the difference are:
- Owners’ drawings or dividends
- Tax and VAT payments
- Loan repayments
- Purchases of assets
- Increases in stock
- Increases or decreases in debtors and creditors.
You can begin to see why the cash flow statement is such a useful tool that should be in every business owners’ toolbox.
Modern accounting software such as Xero and Quickbooks produces a cash summary automatically; todays challenge is to find (or prepare) your cash summary and discover your net operating cash flow over the past six months. Is it positive or negative?
In tomorrow’s challenge we’ll be digging deeper in cash flow by turning the spotlight on your working capital and how to calculate your working capital requirement.