20. Understanding Your Business's Cash Flow

The cash flow statement is one of the three standard financial statements for businesses. Yet it's an engima for many business owners.  It's typically the least used and understood of the 3 standard financial statements. Yet it's a vital tool to helping you understand how your business generates and uses cash flow. 

And that understanding and knowledge is key to managing your cash flow.

Join me for this week's episode where I help you understand your cash flow statement. You'll learn:

• What the cash flow statement is and how it's different from the other financial statements
• The 3 activities that drive your cash flow
• Why the cash flow statement is important

Mentioned in this episode:

• Get your free guide to 10 Ways to Improve Your Cash Flow
• Continue the conversation and book a free call

For the full show notes, including the transcript, go to www.carlamoats.com/podcast/episode20

This episode was produced by The Podcast Teacher.

DISCLAIMER: The information in this podcast is for informational purposes only and does not constitute an accountant-client relationship. While we use reasonable efforts to furnish accurate and up-to-date information, we assume no liability or responsibility for any errors, omissions or regulatory updates.

Transcript

Hello there, and welcome back to the Purposeful Profit podcast. I'm Carla Moats, your host, and I am a fractional CFO and financial consultant for small business owners. My mission is to help you make more profit and improve your cash flow in your business. I am back this week talking about cash flow. Like I said last week, almost 70% of businesses say they have cash flow issues, and that's closer to 95% when they come to me, and 82% of businesses that fail will fail due to cash flow issues. So cash flow is super important to a business. 

This week, we're going to talk about the financial statement that is probably the least understood or used report with business owners that I work with, that is the cash flow statement. The statement of cash flows is one of 3 generally accepted accounting principle financial statements. It's one of the 3 core statements. But when I meet with most business owners, they're looking at the P&L. They might be looking at the balance sheet, but they are not looking at the statement of cash flows at all. So I'm going to educate you a little bit on that today. 

So we're going to dive in. But first, I want to give a word about cash basis. So If you're listening, depending on where you're at in your business, you may be using the cash basis. Most new businesses will, particularly service-based businesses, they will use cash basis and even mature businesses 1,000,000 of dollars. I've got clients that'll come to me that are making 7 figures in their service businesses and even nonservice businesses. I was working with construction clients that are making millions of dollars, and they're on the cash basis. This podcast doesn't really apply to you, but I think it's still worth listening to because the cash flow statement is really not going to be all that meaningful if you are on a cash basis of accounting. 

If you're on the cash basis of accounting, the cash flow statement is just not near as useful. Because in cash basis accounting, revenue expenses are recorded and simply when cash is received or paid. Transactions are recognized when money physically changes hands. In contrast, under accrual basis, transactions are recognized when they are incurred or earned, regardless of when the cash is exchanged.

Cash basis accounting can be used for taxes as can accrual. But if you are getting audited or attested financial statements signed off on by a CPA, you have to use generally accepted accounting principles. Generally accepted accounting principles require you to use accrual because it is a better overall view of your business. So cash basis does not reflect the full financial picture of a business. So a cash flow statement that was prepared under the cash basis of accounting would essentially just be a record of cash receipts and disbursements during a specific period, which is essentially what your profit and loss is. It's just organized differently. It can provide you some insights to how liquid you are, But it's just not going to give you a very comprehensive review of your financial performance. 

So if you know you're on the cash basis, I certainly encourage you to listen to this. Because even if you're not using the cash flow statement. This will help you understand what it could help you with, maybe determine if at some point you want to go to accrual accounting and at least Understand the elements of cash flow better. I will also say that if you think you are on accrual basis, Are you using full accrual, or are you just using a hybrid? I've had clients come to me who tell me they're on accrual. But when I look, the only thing that's accrual is that they're invoicing. So they have accounts receivable, and their payroll is being recorded. When they make a payroll, their bookkeeper's recording the liabilities related to the payroll, but they're not on full accrual. So if that's the case, again, you have accrual, but you don't have a full picture of your business. 

So when I'm talking in this podcast about accrual, I'm talking about you're doing full accrual, something that you're going to need an accountant for. This is not something that's going to be in the scope of a bookkeeper unless that bookkeeper also happens to be somebody who has an accounting degree, has accounting experience, understands gap. Maybe it's a CPA who started their bookkeeping practice, then it can. But your typical off-the-shelf bookkeeper is not going to be able to do accrual. They're going to need accounting support.

So let's dig in here to the cash flow statement. The cash flow statement, like I said, is 1 of 3 statements. It's a financial statement that provides a summary of how your business generates and uses cash over a specific period of time. Typically, you run it for the month, for the quarter, or for the year. It's one of your 3 major financial statements, the other one being profit and loss and balance sheet. Profit and loss, it shows all my revenue and all my expenses and my profit. And then my balance sheet shows my assets, my liabilities, and my equity. And then you have the neglected statement, the cash flow statement. 

But by analyzing the cash flow statement, you can assess whether your business is generating enough cash to meet its operational needs, Whether you have the money to pay or to invest in growth and whether you can service your debt. Paying close attention to the cash flow statement can also help you identify trends in your cash flow patterns. And a word here: if you are sitting out there and you have plans to attract an investor or to sell your business if you're looking to make an exit. Those parties will be very much interested in your cash flow statement because, surprise, Investors or buyers don't want businesses that have cash flow issues, not unless they're buying at a huge discount and their plan is to turn it around. 

So we're going to talk about the 3 drivers of your cash flow. And if you go run a cash flow statement and if you are using accrual and you are not getting a cash flow statement from your bookkeeper, that's the first thing you need to address. But the sections I'm going to go through are the sections of the cash flow statement. Basically, the cash flow statement shows your cash generated or used by operating activities, investing activities, and financing activities. So it breaks it into 3 sections. 

So the section of operating activities, this includes the cash flows that your business generates or uses from your core business operations. It typically includes cash you get from your customers, Cash you pay to your suppliers or vendors, your salaries, contractors, if you have contractors.Interest received, interest paid. It assesses your ability to generate cash from your day-to-day operations. So if that number is negative, it means you do not have enough cash in your business to cover your operations. You're not generating enough cash to cover your operations, and that's one of the first things you want to go look at. 

Then you have investing activities. This section reflects cash flows related to the acquisition or disposal of what we call long-term assets. Now long-term assets are assets that are going to be held for more than a year or take more than a year to convert into cash. These are things like property, plant equipment, investments.  Investments in stocks, bonds, other securities are included here, cash you use to purchase new capital expenditures, machinery, equipment. And if you happen to sell any assets, say, you had a piece of equipment and you sold it to purchase a new piece of equipment, The sale of that asset will also show up in this section. 

Then finally, you have financing activities. This section details the cash flows related to Issuing and borrowing money, so taking out loans, cash payments you've made to repay debt or distribute dividends to yourself, or if you have any outside shareholders, dividends to shareholders. So owner investments, owner distributions are here.

So those are your 3 sections. Let's talk about why you care about that cash flow statement. Why, if you're not getting it from your bookkeeper and you look at it and you don't really understand it. Why should you be looking at it? 

So let's talk about liquidity management. The cash flow statement helps you understand your business's ability to meet its short-term obligations. So you're getting bills. It helps you understand whether you have enough cash on hand to pay your bills, cover operational expenses, And take advantage of opportunities as they arise. Again, if I am someone who's going to buy a company, I want a company that is very liquid, and that can pay their day-to-day bills. That is an attractive investment opportunity. So maintaining a healthy liquidity is essential for your day-to-day survival. 

So a lot of these businesses that you know, when I was talking about 82% of them fail. If I could look at their cash flow statements from the last year, I'm going to guess liquidity was part of their issue. They probably were not able to consistently pay those bills. 

Financial stability. By monitoring your cash flow, you can identify potential cash shortages or surpluses and take proactive measures to address them. So you can go out and mitigate it. You see that you've got some cash shortages, you can go about, how can I bridge that gap? 

Investment and growth. If you want to scale, you want to grow your business, want to expand your operations, acquire new assets, and invest in research and development. You need to have cash for that. It lets you know if you have sufficient cash flow to fund that or if you have to go seek additional financing. If you're a business with debt, it helps you assess your ability to repay your loans. If you go out and get a loan, Depending on the size of the loan and the bank and the nature of the business and how long you've been with the bank, they're going to ask for a cash flow statement potentially. They're going to scrutinize your cash flow because they want to make sure that if they're going to give you that $1,000,000 loan or a $1,000,000 line of credit, You have enough money to repay them. 

Strategic decision making. The more in-depth you get in the cash flow statement, the more you really understand it. You can look at things like, Should I offer extended credit terms to customers? When should I pay my suppliers? How much should I invest in marketing or other initiatives? How much can I put into research and development? Are there ways I should go out and try and find to escalate my cash collections? 

I've already talked a little bit about the next one, investor and stakeholder confidence. Again, if you're trying to sell or you're trying to attract an investor or a partner, they want a well-managed cash flow statement. If you do not have a well-managed cash flow statement, you're going to be selling your business at a discount. 

We talked also already about risk mitigation. The cash flow statement is something that's already happened. We talked in last week's episode about the importance of a cash flow forecast. So the cash flow statement has already happened. But it allows you to identify some potential risks and develop contingencies and plans. Cash flow statement doesn't replace cash flow forecast. They work best together.

We can do a forecast, and then something can change. Maybe you were forecasting a big client payment because they promised to pay you $100,000 on their account and that they only paid $50,000. So your cash flow statement comes back. It wasn't what you forecasted. You can at least now identify that, and you can mitigate your risk. You can take proactive steps to cut costs or increase your revenue so that you don't have a cash crisis. 

So what do you do next? Again, if you are using the accrual basis of accounting, make sure you're getting that statement from your bookkeeper. If not, go ask for it. And then do you understand it? Take a look at it. Do you understand it? And if not, if you want help understanding it. I'm working with a client now who just wanted to understand their statements. They're really not ready for full-on fractional CFO services, but they really wanted just to understand their financial statements. So we have a project where we're just meeting and we're doing a deep dive into the financial statements. So that's the type of project work I can do with clients. You can go to www.carlamoats.com/workwithme, and you can book a call. 

Thanks for joining me today. If you want more ideas for improving your cash flow, go to www.carlamoats.com/cashflow to get your guide to improving your cash flow. You will get actionable tips for improving your cash flow that you can start putting in place today.

I will see you next week.