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Cash Flow Or, Where did the Money Go?
It has been written that cash flow is the "life blood" of business. Whether you like this metaphor or not, you probably would like to have a better picture of the flow of money through your business, and, of course, more flow.
The Cash Flow Statement is often included with a company’s Balance Sheet and Statement of Income and Retained Earnings (also referred to as the Profit & Loss Statement, or simply, the P&L) when complete financial statements are presented. The Cash Flow Statement shows the sources of cash that the business took in over a period of time and the uses of cash. The reason that the Cash Flow Statement is required by the professional rule-making bodies that establish what are known as Generally Accepted Accounting Principles (GAAP) is that modern accounting has become as complicated as modern business. The traditional financial statements, the Balance Sheet and the P&L Statement, do not provide sufficient information to indicate how much cash is generated by a complex business enterprise and how much cash it spends. There are too many expenditures that effect the Balance Sheet, e.g., investments in plant and equipment, long-term and short-term financing, special sales arrangements, etc. There are also many allocations, deferrals, charge-offs, and accounting adjustments that can result in there being a great difference between the reported Net Income (the so-called "bottom line") and the Net Cash Flow. These adjustments, while useful in matching revenue with related expenses, may give management the opportunity to manipulate the figures: if there is not enough profit to report to shareholders or financial analysts, reclassify some previously deferred revenue as current revenue. Or capitalize certain expenditures that would normally be treated as current expenses.
What is interesting about the Cash Flow Statement is that it eliminates most of the adjustments and possible manipulation of accounting data. Cash is cash. There was a certain amount of cash at the beginning of the year; and there is a certain amount of cash at the end of the year.
Before GAAP required the Cash Flow Statement, financial reports contained a Statement of Financial Changes, and before that, a Statement of the Sources and Uses of Cash (or Statement of Sources and Applications of Cash). Any of these statements, if properly prepared and carefully presented and studied, can increase your understanding of the flow of cash through the business.
It has been my experience that even for a small business, the Cash Flow Statement can be an eye-opener for the owner. The reason is that the P & L Statement is usually prepared on an Accrual Basis of accounting, not on a Cash Basis. Moreover, the P & L Statement does not include non-income sources of cash and non-expense uses of cash. Thus, it is possible that sales look good, and net profit looks good, but there is no cash to pay bills, or to take out of the business and spend. The Cash Flow Statement may highlight the fact that although sales were good last month, those sales resulted in a big increase in Accounts Receivable, but not much cash. The Accounts Receivable have to be collected (a source of cash) in order to pay suppliers and employees.
The Cash Flow Statement can also show that the cash generated by operations was used to buy equipment, which is called an Investment Activity, or used to pay back loans, which is called a Financing Activity. Or, perhaps the owner drew out the money from the business in order to eat, or the Company paid dividends to the shareholders. Paying suppliers and employees, buying equipment, paying loans, and taking the money for personal uses is Where the Money Goes. A well-crafted Cash Flow Statement, or Statement of Sources and Uses of Cash, can document and show Where the Money Went. And when you know this, perhaps you can increase or speedup the inflow and decrease or slow down the outflow of cash.
Copyright © 1999 Ira M. Freed |
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