The right way to use a cash flow statement

Money in, money out

Cash flow truly is king for the small business owner. According to a U.S. Bank Study, a shocking 82 percent of businesses fail due to issues with cash flow management. Staying on top of your cash flow is crucial to not only your business thriving, but more importantly, simply surviving. And the best way to keep your small business above water? Get a handle on your cash flow, which requires mastering the ominous cash flow statement.

What is a cash flow statement?

A cash flow statement allows you to track the amount of cash your business has coming in, and how much it has going out — or simply put, the amount of cash you’ll have available to you — in a given period of time. If you’ve invoiced a customer, you shouldn’t be including that transaction in your cash flow statement until you actually receive the payment.

Preparing a cash flow statement is key to understanding, and improving upon, how you spend smarter on a day-to-day basis.

 

Ideally, you should be aiming to perform a cash flow analysis on a monthly basis to ensure you have sufficient cash on hand, and to prevent encountering problems like being blindsided by a cash flow crunch. By creating these statements regularly, you’ll be able to identify patterns in your cash inflows and outflows, and make more informed decisions in how (and when) you choose to use your cash.

So, what do you actually include in your cash flow statement?

What to include in your cash flow statement

Cash flow statements are made up of three main categories: operating activities, investing activities and financing activities.

Operating activities

Operating activities are the cash inflows and outflows directly related to the daily operation of your business. When a customer buys your product or service, that’s your inflow. When you pay employees, vendors, insurance or miscellaneous taxes, these expenditures all fall under outflows. You can find this information on your income statement (more information on this later).

Investing activities

Purchasing a new piece of equipment or expanding to a new location are examples of investing activities. These tend to be big purchases, and considered as long-term investments of assets.

Financing activities

Financing activities have to do with cash investments or borrowing money. As an example, if you’ve decided to take out a $50,000 term loan, the incoming cash will be counted as an inflow. Your payments on that loan will be considered as an outflow.

The right way to use a cash flow statement

There are two methods of building a cash flow statement, but we’ll be focusing on the indirect method today (as it’s more straightforward, and much more common). To properly prepare your cash flow statement, you’ll need to have your income statement and balance sheet on hand.

Step 1: Determine your net income

You can find your net income by referring to another key financial document: the income statement. Your income statement reflects your operating activities. Your net income is a product of your total revenue and gains, in a given period of time, minus your total expenses and losses, over the same period of time. However, your net income is not the same as your cash flow.

Step 2: Convert your net income from operating activities to net cash (flows)

Your income statement is based off of the accrual method of accounting, and thus adjustments need to be made to reconcile net income with net cash. Why? Because with the accrual method, as Mary Juetten notes, “you have a policy for when you recognize revenue, usually tied to doing the work or providing the service, and you record your expenses when a commitment is made, like when you agree to pay someone or sign a contract.”

This means your income statement reflects losses or gains that might not actually be reflective of the cash you have on hand. Here’s an example:

You’re a florist. On October 1, you sell $5,000 of flower arrangements to your customer for her wedding. You send an invoice with a deadline of 60 days (she’s busy with the wedding!). You also have to pay your vendor $2,000 for the supplies (flowers) within the next 30 days. Your net income would be $3,000.

Sale + $5,000
Expense   – $2,000
Net income + $3,000

Pretty simple, huh? But, this doesn’t paint an accurate picture of the status of your cash. The cash basis of accounting is used much less, but provides you with your net cash. Why? Because revenues and expenses aren’t recorded until the money is actually received. Take a look below:

October 1 November 1 December 1
Inflow 0 0 $5,000
Outflow 0 – $2,000 0
Net cash 0 – $2,000 $3,000

Why does this matter? Because if you were creating a cash flow statement for the month of October, saying you had $3,000 in net cash would be grossly inaccurate. So, how do you go about adjusting the items on your income statement from accrual to cash?

Look at your balance sheet and income statement, and make appropriate adjustments to your net income by adding or subtracting any applicable changes (in cash) for your payables, receivables, expenses and/or inventory (and any other changes in assets or liabilities). Don’t forget to factor in non-cash expenses such as depreciation as well.

Cash Inflows Cash Outflow
+ Decrease in accounts receivable – Increase in accounts receivable
+ Decreases in inventory – Increase in inventory
+ Increases in accounts payable – Decreases in accounts payable
+ Decrease in prepaid expenses – Increase in prepaid expenses
+ Increase in taxes payable – Decrease in taxes payable

Step 3: Calculate the net cash from investing activities and net cash financing activities

Once you get through the somewhat complex task of calculating your net cash flow from operating activities, it gets much easier. You’ll simply need to calculate your net cash flow from investing activities, and net cash flow from financing activities (examples of what to include are mentioned in the section “What to include in your cash flow statement” from above). Each of these categories require merely adding your inflows, and subtracting your outflows — no adjustments necessary!

Once you have a number for net cash flows from operating activities, net cash flows from investing activities, and net cash flows from financing activities, add these three values together. This will provide you with your net increase (or decrease) in cash flows for the given period of time — whether that’s a day, week, month, quarter or year.

Conclusion

Having a negative cash flow isn’t necessarily the end-all, be-all; however, if you start to see this pattern recurring for more than a few months, it’s probably the right time to make some adjustments in your operations. And while preparing a cash flow statement isn’t easy, it can make all the difference in the ultimate success of your business.

Samantha Novick
Samantha Novick is the Social Media Manager and oversees content at Bond Street, a company revolutionizing small business lending through technology, data and design. Small business owners are the foundation for growth in our economy, and yet today’s banking system has left them behind. Bond Street is building a better future where access to financing is simple, transparent and fair.