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This is part four in a series of blogs we’ve created to help you, the small business owner, be able to better wrap your head around your essential financial reports. So far we’ve covered:

 


So if you’re just joining us, I highly recommend that you go back and read those articles so you can catch up.

Don’t worry. We’ll be here when you get back.

(Humming “Eye of the Tiger…”)

Ok! Welcome back! Here we go with Part 4: Cash Flow Statements.


In keeping with the bike-riding analogy we’ve been using (you did just read about that in the other articles, didn’t you?), this report will be the third wheel we’re adding. So by the time you’re done with this one, as you’re learning to “ride” your financials, you’ll probably start feeling pretty stable. Kind of like you did as a kid riding a tricycle or one of those Big Wheels.

In the intro to this series, we said, “If the balance sheet shows you where your money is, the cash flow statement shows you where all the money went.” It solves the mystery of why your bank account and your profit totals don’t always add up.


What is the Cash Flow Statement?

 

As the name would imply, your cash flow statement is simply a report that shows how cash flows into and out of your business.

 

It shows the activity related to cash in these three groupings or main categories:

 

  • Operating – This is where purchases you had trouble reporting on your income statement, because they hadn’t generated income yet, show up as a cash expense. For example, raw materials used to make a widget you haven’t sold yet. This shows the change in balance sheet accounts over time that haven’t impacted your profit and loss statement yet. So if you had $1,000 sitting on your shelf before as inventory and then you bought $5,000 more of a product to sell but haven’t sold it yet, this statement would show that inventory (which is now $6,000) has spent cash of $5,000. The inventory is on your balance sheet for $6,000 but nothing hit your profit and loss yet. So that explains why you may have made a profit, but there isn’t money in the bank from that profit yet. Some of the items that would show up in this grouping would be:
    • The change in accounts receivable over a period of time
    • The change in accounts payable over a period of time
    • The change in inventory over a period of time

  • Investing – This is for long-term assets such as fixed assets (equipment, furniture, buildings, automobiles, etc.) and PP&E (property, plants, and equipment Items including:
    • Land
    • Buildings
    • Equipment
    • Company Vehicles
    • Furniture

  • Financing – This is the area of your cash flow related to your liabilities (i.e. loans) and equity activity (owner’s draws or distributions.) When you make a principal payment for a loan, you owe money on the principal. Payment isn’t reflected on your profit and loss report, but the cash still left your bank account. When you take money out for yourself as a draw this isn’t on your profit and loss, but it is out of your bank account. Most commonly, you would include:
    • Changes in loan balances
    • Amounts taken out of business accounts as a draw to the owners or partners over a period of time

 

3 Things You Should Understand about Cash Flow

 

    1. It is derived from both your balance sheet and income statement.

      Using the indirect method of accounting, which most companies do, the “net earnings” shown on the income statement is the number used in the cash flow statement. And depending on which period the cash flow statement is reporting, you would use two balance sheets to show the change between that period and the previous one.

      For example, if you are generating a cash flow statement for August 2018, you would use the balance sheets from July 2018 and August 2018 to demonstrate that the net cash flow equals the increase or decrease in cash between those two periods. 
    2. It shows whether or not you can pay your bills.A creditor or potential investor would look at this to see if you have enough positive cash flow to be able to pay your expenses. Generally, the more cash on hand, the healthier a company is. It’s where the phrases “cash cow” and “cash is king” come from. It can give people looking into your business a good sense of whether or not they want to do business with you. (However, it’s not the only thing they should look at. A negative cash flow for a certain period could actually reflect explosive growth and lots of cash being spent to make that happen.)


    3. Cash is not the same as net income.Timing. Timing. Timing. Just because you are showing a profit doesn’t mean the cash is in the bank. The examples above show all that goes into the change in your bank balance over time. These are cash flow changes, however income and expenses aren’t the only items that hit your bank account or, better yet, income and expenses sometimes haven’t even hit your bank account yet. That’s why it takes all three reports working together to get an accurate picture of your numbers.

 

Dig Deeper

 

Check out this video from Kahn Academy if you’re interested in learning even more about cash flow!

 

All Done, But Stick Around

There you have them: your three basic financial reports.

  • Income Statement (a.k.a. P&L)
  • Balance Sheet
  • Cash Flow Statement


Hopefully, you’ve been able to get a better understanding of what these reports are and how valuable they can be to your small business. We deal with these every day, so we’d love to partner with you and help put them to work for your business.

What you can learn from these reports makes a huge difference, but it gets even better. We’ve got one more bonus treat for you! Next time, I’ll introduce you to a report we came up with here at Patrick Accounting called the “Scorecard.” It’s the fourth wheel and allows you to really move!
I think you’re going to love it!

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