Cash Flow Statement: The secret sauce for 2x business growth

A survey by  QuickBooks revealed that 60% of small businesses face problems with cash flow. Interestingly, to better understand whether your business is doing good or bad, you need to understand the cash flow statement and how to prepare one.

In this blog, I will discuss the importance of cash flow statement, how to prepare and calculate one for your business and towards the end I will share a few tips and the importance of cash flow management in business.

But first let’s quickly go through some basics.

What is Cash Flow?

The amount of money that comes in and leaves your business is called the cash flow. If the cash coming into your business is more than the cash going out, it is called a positive cash flow. But if the cash inflow is less than the cash outflow of the business, then it is called a negative cash flow.

Let’s assume you are a restaurant business owner, and in May you had a total revenue of $10000, and by the end of the month your total expenses were $8000. This leaves you with a profit of $2000. In this scenario, your restaurant business is in a positive cash flow state.

But, instead of $8000 if your business had incurred a total expense of $11000, you would be left with a deficit of - $1000, and this would be called a negative cash flow.

Why is that a big deal?

If your restaurant business is in a positive cash flow state, you are in a good position to launch a new marketing or sales campaign, re-invest surplus income to improve the restaurant ambience, and even invest in new kitchenware.

But if your restaurant business is in a negative cash flow state, chances are that you will struggle to launch a new marketing or sales campaign, invest in the restaurant ambience, expand ingredient inventory or buy kitchenware, and may face a lot of challenges in delivering services to your customers.

Now that you know what cash flow is, let’s move on to the next level – the importance of cash flow statement.

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Why’s Statement of Cash Flow Important?

Let me illustrate an example where you are a small retail shop business owner who is reviewing the following statement.

Sale of goods $1000
Employee salary -$200
Utility payment -$100
Cost of goods -$500
Profit $200

It is very clear that your business made a profit of $200.

But now consider this, out of the $1000 worth of goods you sold, you have given a credit of $600 worth of goods to customers at zero percent interest rate. They enjoy a 60-day credit period, so you can’t expect them to make the payment earlier than that. This means you have only received $400.

On the other hand, you will have to credit salaries on time to your employees and make timely payment to the utility company.

Payment received ($400) - [ Employee salary ($200) + Utility payment ($100)] = $100

Now you are only left with $100 as profit.

But wait, there’s more, 6 months back, the wholesale vendor and you had an agreement that he would only ask for monthly payments after 6 months of credit period. So, from this month you must start clearing his due payment which is $500 every month.

Profit ($100) - Vendor payment ($500) = Cash Deficit (-$400)

This means you must now invest an extra $400 to keep your business afloat.

Based on the above details, your cash flow statement would look like this:

Cash Flow Statement May 2024 
Operation Activities   
Net Income   $400 
Employee salary  -$200 
Utility payments  -$100 
Vendor due payments  -$500 
Investing Activities   $0 
Financial Activities   $0 
Net Cash in hand  -$400 

I think it is clear to you now that the cash flow statement (or statement of cash flows) is a statement that keeps track of:

  • Cash Sources
  • Cash Activities (i.e. operating, investing and financial activities)
  • Transaction Period

I have listed operating, investing, and financial activities for your reference. Depending on the type of business and industry, it could have additional entries as well.

Operating Activities  Investing Activities Financial Activities
Sales receipts of goods/services  Property sale or purchase  Payments from banks or investors
Interest payments Loan given to vendors  Payments made to shareholders 
Income tax payments  Payments related to Mergers and Acquisitions    Payment of debt loan principal amount 
Employees Salary  Sale or purchase of equipment  
Vendor Payments   
Rent Payment and More     

Thanks to a well-prepared cash flow statement you will always be on time

  • In making payments to vendors
  • In crediting employee salary
  • In anticipating company expenses & challenges
  • In spotting new business opportunities
  • In hiring new team members
  • In making strategic decisions

How to calculate a Cash Flow Statement? ...and make your life easy

The cash flow statement is calculated in two different ways – the direct and indirect method Direct method – is a very simple method and is often preferred by small businesses for this very reason. It involves subtracting the cash payable from the cash receivable on a weekly, monthly & quarterly basis. Here’s a cash flow statement example.

Pro Tip: “A Cash Flow statement, Chart of Accounts, and General Ledger go hand-in-hand and are crucial to prepare a robust statement of cash flow.”

                Cash Flow Statement  
Cash receipts from customers  $10000 
Employee salaries  -$1500 
Vendor payments  -$3000 
Interest paid   -$1200 
Income taxes paid  -$8000 
Income before taxes  $50000 
Net cash from operating activities  $46300 

Indirect method – In addition to considering all the receivable and payable amounts, transactions where the cash is yet to be credited in the bank are also considered in the cash flow statement. For e.g. sales signing with a future payment date.

Also, you will consider depreciating expenses which are incurred over a period. For e.g. depreciation of equipment life or depreciation of building shelf life.

In the following table, you will notice depreciation expense – which reflects the reduced shelf life of your assets (e.g. vehicle).

            Cash Flow Statement  
Net income  $10000 
Depreciation expense of van  - $2500 
Equipment sales  $4000 
Accounts receivable  $7500 
Accounts payable  - $4000 
Net cash from operating activities  $15000 

Moving on, let’s understand the importance of cash flow management

Never Take your eyes off the cash flow because it's the lifeblood of business - Sir Richard Branson, Virgin Group

Importance of Cash Flow Management: From the playbook of successful business owners

Address short term challenges – You can easily tide over any short-term financial shortfall (e.g. Machinery repair, warehouse fire) if you are good with cash flow management

Long term sustainability – When you operate your business with cash flow effectiveness, you can confidently forecast business success in the long run.

Attract Funding – You will come across as credible, who knows how to handle money. It won’t be difficult for you to attract investor money.

Leverage opportunities – You will capitalize on opportunities like acquiring competition, quality equipment, new shop location etc. that you can’t afford otherwise.

Accelerate growth – Once you master the art of cash flow management in business, your business gains tremendous momentum. This will set you up on a guaranteed path to success.

Now without much further ado, let’s see some of the important cash flow management tips.

Cash Flow Management Tips: The secret no one tells you

Monitor cash flow regularly: You should make it a habit of preparing & reviewing cash flow statements. This way you will avoid any nasty last-minute surprises.

Maintain relationships: Effective communication, respect, and a collaborative approach goes a long way in securing flexible payment options with clients and vendors.

Contingency plan: Have a contingency plan (at least three months) to overcome an unanticipated challenge. A cash reserve or Line of Credit can come in handy in such situations.

Hire professionals when necessary: An accountant or an outsourced accounting partner can certainly save you a lot of time & money by relieving you from all the time-consuming tasks that keeps you away from focusing on your core duties.

Use technology: There are accounting related applications available in the market that can help you keep track of the accounts payable traffic. These apps can easily automate a lot of manual processes and simplify payment workflows.

As a small business owner your aim is to cater to your customer’s needs without jeopardizing business continuity. Of course, you don’t have to become an accountant to make this happen, all you need is financial awareness and to avoid simple yet expensive accounting mistakes.

Published on: Jul 09, 2024

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Author

John Bugh

John Bugh is the Chief Revenue Officer for Pacific Accounting and Business Services (PABS), responsible for the strategic direction, planning, vision, growth, and performance of the company’s marketing, branding, and revenue streams.

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