You probably didn't start your business because of your enduring love for detailed bookkeeping. It's not that you don't care about the money; it's just that you'd much rather be designing bespoke websites or devising attractive financial plans for your clients than keeping track of all the numbers. Don't worry; you're far from the only small business owner who puts your accounting-related tasks off for as long as legally possible, and it isn't that important – unless you want to grow your business.
Proper accounting is not optional as your business grows and you add employees, clients, vendors, and equipment.
Take cash flow statements, for example. They may not seem essential or beneficial to your business, but accurate cash flow statements are crucial to keeping track of your business's operations. Keep reading to learn more about cash flow statements, why they're essential, and how to read them.
What is a Cash Flow Statement?
Cash flow statements are precisely what they sound like: financial statements that show the amount of cash and cash equivalents that come and go from a company's accounts over a certain period. They, along with income statements and balance sheets, provide an invaluable high-level view of the financial health and operations of all different kinds of businesses.
Companies produce quarterly and yearly cash flow statements to complement and fill in the profit and loss statement and balance sheet gaps. You can think of the 'big three' financial statements as three pieces of a puzzle. The balance sheet shows a snapshot of a company's financial situation for a given point in time, and the statement of profit and loss shows how much revenue and expenses a company incurs over a given period. The statement of cash flows provides a more granular view of how cash and cash equivalents flowed into and out of the company over the same period.
Okay, But Why Are Cash Flow Statements Important?
In short: cash flow statements are important because they help businesses measure how well they manage their cash. Cash flow statements give the stakeholders of a company the chance to see how much money it generates, where that cash comes from, and how much it's spending on debt and operating expenses. This is useful for a few reasons:
First: Clarity. Most small business owners have at least some idea of where their firm's cash comes from and where it goes. Still, only an exact cash flow statement will give you the precise numbers you need to identify potential risks and opportunities accurately. That clarity is worth the effort it takes to put together a cash flow statement.
Second: Potential lenders and investors. You can't just walk into a bank or a conference room and expect success unless you have detailed financial statements. Lenders won't even consider applying for loans or lines of credit unless you can show them exactly how well your business is performing, and the same goes for potential investors.
And finally: Planning. Making precise predictions and firm plans for the future is impossible if you don't know exactly how much your business is making and spending. You need strong numbers to project future earnings and expenses, and the best way to get those numbers is to put together cash flow and other financial statements.
So now that you know a bit about why cash flow statements are essential for businesses of all shapes and sizes, let's talk about how to read them.
How To Read Cash Flow Statements
Cash flow statements are made up of a few primary components related to the cash flows from various activities:
- Operating Activities
- Investing Activities
- Financing Activities
Cash Flows from Operating Activities
This section shows the amount of cash a company earns and spends from selling products and services minus the money it spent on business-related expenses in the same period.
The exact line items differ from company to company. You'll usually see a few similar entries across the board. A cash flow statement will typically show positive (incoming) cash flows from business activities like selling products or providing services, and negative (outgoing) cash flows from paying wages, buying supplies, paying rent, and other operating expenses.
Cash Flows from Investing Activities
This section measures the amount of cash spent on or raised from changes in a company's assets, investments, or equipment.
If your company sold a building or bought a piece of equipment, your statement of cash flows would reflect the gain (or expense) in this section. This section will sometimes show negative cash flow, but that's not always bad. Buying a new truck or factory equipment can easily create significant negative entries in this section, even though they may end up paying for themselves and generating more profit in the long run.
Cash Flows from Financing Activities
This last section reflects a company's cash from or is paid to investors, lenders, and shareholders. Smaller companies may have line items for paying back loans and capital raised from investors. Big companies may have extra line items for things like paying dividends, buying back stocks, and money received from selling bonds and spent on repaying bondholders.
Cash flow statements show stakeholders how well a company manages its cash. They show how much money a company made from different sources, how much it paid on various expenses, and what kind of money the firm spent on investments like new equipment or floor space. And while they don't provide as complete a picture as balance sheets or income statements, cash flow statements are still handy for small business owners. An overview of where cash comes from will provide the operational clarity you can't get when you're in the weeds. It's an absolute necessity when trying to make plans, apply for loans, or convince potential investors to buy in.