Financials The GPS Of Business Part 4 The Cash Flow Statement Overview

Aug 11, 2009


We men have a reputation for not asking for directions when we are lost – well not exactly lost - it just that the trail has just become a bit uncertain.  Imagine having a GPS, one of those wonderful little machines that can track your location within a matter of feet, but not being willing to use it.  That seems analogous to NOT including the Cash Flow Statement as a key tool for monitoring your business.   


Most businesses operate on an accrual basis.  Revenue is recorded when earned – not necessarily when received, and expenses are recorded when incurred – not necessarily when paid.  This makes the use of the Cash Flow Statement particularly important.  For instance, some of the revenue the business earns, doesn’t actually represent cash coming into the business - credit sales, for example.  By the same token, some “expenses” recorded in the income statement don’t actually involve an outlay of cash - depreciation for instance.  Consequently the flow of cash into and out of the business can be considerably different than reflected in the Balance Sheet and Income Statement.  Having a profitable income statement is no guarantee that the business will succeed or fail.  Cash is King, and the only way to determine the availability of cash in the business on a consistent basis is to include the Cash Flow Statement as a key financial reporting tool.


After years of working with small businesses, I can only conclude that business owners must find the Cash Flow Statement particularly hard to understand.  Otherwise, why wouldn’t every one use it on a consistent basis?   The purpose of this article is to take some of the mystery out of this critically important statement.  Because on the desire to be thorough in the explanation of the Cash Flow Statement, this article will provide an overview of the Cash Flow Statement and a following article will provide an example of the preparation of the Cash Flow Statement.


There are two forms of the Cash Flow Statement – the Direct and the Indirect.   The Indirect Cash Flow Statement, starts with the Income Statement and then is adjusted for several non-cash entries.  The Direct Cash Flow Statement, as its name implies is much more direct.  It is similar to the checkbook and I find it is generally less complicated.   Because of the limit on space, this article will address the Direct Cash Flow Statement only.  


The Cash Flow Statement is beneficial in two regards.  First, the Cash Flow Statement explains where the cash came from and where it went for the past period, say a week or a month.  Second, the Cash Flow Statement is valuable as a projection tool, helping to anticipate the future cash demands of the business.  


The Cash Flow Statement can be prepared for any period length desired.  However, the longer the period used, the less meaningful the cash flow statement is for guiding the daily business decisions that impact cash.  For companies that the availability of cash is a concern, I suggest that the Cash Flow Statement be prepared on a weekly basis and that the expectations for the sources and uses of cash be projected for at least eight to twelve weeks into the future.


  The difference between the beginning and ending balance of the primary cash account used by the business is what the Cash Flow Statement seeks to explain.  Building the Cash Flow Statement begins with the Balance Sheet which is the principle source for most of the information regarding the sources and uses of cash.  


The cash impact from the change in the balance of each Balance Sheet Account is reviewed.  For instance, a decrease in the balance of the inventory account may be offset by either a increase in Cash or an increase in Accounts Receivable.  In the first instance there is a cash impact.  In the second, the cash impact is deferred and in essence the business has become a bank for the customer.  Conversely a increase in Inventory may be represented by an decrease in Cash or an increase in Accounts Payable.  Again, in the first there is a cash impact.  In the second, you have deferred the use of cash and the vendor has acted as you banker.  Each additional Balance Sheet Account is similarly examined for its cash impact.


Amortization and Depreciation are two accounts for which there is NO cash impact.  While there is a cash impact at the time of actual purchase of a piece of equipment, there is no actual cash impact when depreciation is recorded.  Depreciation simply represents the allocation of a portion of the value of the equipment to each accounting period without any impact on cash.


In the next article, I will walk through an example of the preparation of the Cash Flow Statement.





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About the Author

Steven D. Olson, CPA, has extensive experience in a wide range of leadership, management and advisory positions. In the role of Chief Financial Officer, he provides executives with timely and accurate financial statements, ongoing cash flow projections, oversight over accounting and finance operations, as well as design and maintenance of the financial reporting structures.

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