(Note: This is a not yet published article for Tentho.)
Financial health is a strong indicator of the chances of success and longevity of a business. Part of that metric is a company’s cash flow, or the amount of money they have coming in and going out at any given time. A statement of cash flow provides detailed information on past data, illustrating when and how money is being utilized. This statement is crucial for small business owners, as it goes beyond just sales and revenue. While these numbers are important, if the whole picture is not being examined, then debts could accumulate and the business may operate at an unexpected loss.
Whether the bookkeeping is done in house or an outsourced CFO is used, a cash flow statement plays a key role in keeping operations on track. First, it can help with the preparation of a budget and identifying if it is being followed. Knowing this information can help a company take better steps related to financial planning and forecasting. Furthermore, it can point out patterns of strong and weak cash inflow and outflow, which allows a company to plan their spending and investing. If there are particular times of excess cash, this money can be allocated toward additional expenses or growth opportunities.
Statement of Cash Flow
There are three main categories of a cash flow statement:
- Operating Activities – This relates to any cash generated by the product or service that the business offers and expenses like employee wages or rent.
- Investing Activities – This relates to assets bought and sold, like buildings or equipment, or loans given out and taken.
- Financing Activities – This relates to cash received from investors or banks and any money the company pays out to shareholders.
These all combine to show the net cash flow. Ideally, this will result in a positive number, but having negative cash flow doesn’t necessarily mean something is wrong. It may just point to a period of increased expenditure for the purpose of expansion. This demonstrates the importance of cash flow statements as part of small business accounting though—to know where money is going to or coming from and these records can be prepared in one of two ways.
Direct
The direct method of cash flow accounting takes into consideration only the explicit cash transactions and ignores any possible changes due to depreciation or unrealized investment gains. This is considered more accurate as there are no adjustments that need to be made, but given certain factors are left out, may not offer as complete of a picture.
Indirect
Alternatively, the indirect method of cash flow accounting begins with net income and includes non-cash assets and liabilities to create the overall statement. While this leaves additional room for errors in the bookkeeping, a more holistic picture is presented.
Cash Flow Forecasting
While the statement of cash flows looks backward and demonstrates how the company has fared historically, a cash flow forecast seeks to estimate inflow and outflow for an upcoming time period. Before doing any forecasting though, a company should have a vision of what they want to accomplish. Trying to figure out future cash flow does not mean as much if there is no plan for how to use it. Once the goals are established, then this process becomes more beneficial and almost equally as important as a cash flow statement, because it can help predict future outcomes and assist in decision making. Anticipating cash shortages aids in navigating through potentially difficult situations, rather than facing any surprises, which can be detrimental to small businesses.
To create a forecast, first a time period must be established. This can vary in length, ranging from a couple of weeks to a couple of months, or even longer. As the planning goes further out, there is a possibility of reduced accuracy though. Then, for that length, all income and expenses should be listed. This includes planned receivables and expected sales revenue, as well as known expenditures. Finally, calculating the net cash flow can point out any flaws in the plan or areas that need to be addressed.
Tentho Can Help With Your Cash Flow Statements
Tentho has a team of experienced accounting professionals ready to take these tasks off your hands, so that you can focus on growing the business rather than being bogged down in the details. Their experts can create complete cash flow statements and forecasts that you can use to plan and build your company this year and into the future. Schedule your free consultation today.