Keeping track of finances and predicting the profitability of your business in the future can be difficult.
One of the most common reasons for business failure is a lack of cash. However, an effective way of monitoring the ebb and flow of cash is with a statement of cash flows. A statement of cash flows helps evaluate management decisions and predict the ability to pay debts or dividends.
So, what is cash flow?
For those that don’t know what a statement of cash flows is, it is a report on a business’s inflow of cash through receipts and outflow through payments. This explains why cash increased or decreased for a specific period. It’s critical to understand not only the what of cash flow, but also the why.
When a business purchases or sells merchandise or inventory we refer to it as operating activities. Operating cash flow is what most people recognize as the gain or loss of cash in a business.
A cash flow is positive if more money is coming in than going out. If more money is going out than in, you may need to find ways to limit the amount of the money going out. Businesses use something called working capital to act as insurance for cash shortages.
Not all profit is cash. Increases in assets are also treated as an increase in profit for the business. An increase or decrease in long-term assets (property, plant, or equipment) is treated as investing activity.
Another type of profit pertains to an increase or decrease in liabilities and equity. These activities include issuing stock, paying dividends, and buying and selling treasury stock. This type of cash flow is called financing activities.
The last type of cash flow involves investing and financing activities that do not use cash or non-cash investing and financing activities (NIF). An example would be buying equipment with a bond payable.
The statement of cash flows lists all these types of activities and provides a way for businesses to monitor the way they effect the end cash balance for the period.
So, how does this benefit your business?
Predict future cash flows: Tracking expenses throughout your life and how much money you have is a necessity. By saving receipts and figuring out how much you spend each month, you can predict how much you will need to spend the next month.
The same goes for small businesses. Past expenses and income can help predict future expenses and income. The amount of money spent on inventory, wages, bills, and daily expenses is measured for one month and adjusted for the next. Some of the ambiguity of future finances is reduced in this way.
Evaluate Management: By tracking expenses and income, you can then monitor your savings and checking accounts. You can evaluate if you have enough money coming in, what you can cut back on, and make strategic decisions on how you can bring more money in.
For a business, it is important to know if management decisions are effective. A statement of cash flows can help evaluate whether wise investments had been made by management and if not, what changes can be made to increase income. The continual measure of expenses and income can help you make a more informed decision on how to increase the ending cash balance.
Predict ability to pay debts and dividends: When you know how much cash is coming in and going out, you can gauge whether you can take on extra expenses or loans.
A business can show lenders that they are able to take on a loan or service a debt and provide dividends for stockholders.
Do you need help with your business cash flow?
One of the areas where we help your business is with cash flow. We can evaluate your historical flow, assist with projecting future flow, and evaluate your flow against your industry and competition. Most importantly, we can help you pinpoint the why behind your cash flow and help you develop plans to reach your business goals. To learn how, contact your local Kansas Small Business Development center.
About our author
Abby Cahn is a Spring 2018 marketing intern for Kansas SBDC. She went to Cowley County Community College as a Secondary Art and English Education Major and graduated with an Associates in Arts. However, she decided business was the most beneficial route for her. Currently, she is a Fort Hays State University undergraduate student pursuing her degree in Business Management with a concentration in Entrepreneurship. She enjoys creating artwork, reading, and assembling floral arrangements. Abby hopes to open her own small business some day. She wants to teach people how to create floral arrangements and artwork, as well as sell them, from a small shop in Kansas. By doing this, she hopes to promote creativity and art as an outlet for communication, learning, and relaxation. She knows that one day if she needs assistance with her business she will go to her local Kansas SBDC.