The goal of any business should be to have more cash coming in the door than going out. Cash is used to cover your overhead, fund your payroll, purchase equipment, and pay your suppliers. Essentially, your business isn’t going to survive for long if it runs out of cash.

Your company’s cash flow statement includes all of the inflows for your business as well as the outflows to pay for business activities during a given quarter. Here is what you need to know about your cash flow statement, and why it is vital to the success of your business.

Why Your Company’s Cash Flow Statement is Important

Most public companies use the accrual method of accounting. This means that your company will be reporting income as it earns it instead of when payment is received. Expenses are reported when they are incurred instead of when the company pays its bills.

From an accounting standpoint, a company could be earning a hefty profit and even be required to pay taxes. However, the cash situation could be much different. If no money was exchanged yet, but your business had to front supplies, manufacturing, and shipping costs, you might get into trouble.

Cash accounting is different. Income is recorded as payments are received, and expenses are recorded in the period in which they were paid. The profit for a company is shown on its income statement as net income. However, this figure doesn’t necessarily reflect everything.

Your company, again, could appear profitable with this type of accounting, but it could run into trouble if receivables come due and there isn’t cash available. It’s because of these discrepancies that your business cash flow statement is so important.

Dissecting the Business Cash Flow Statement

Your cash flow statement has three sections, each relating to a different business component – operations, investments, and financing. The format of a cash flow statement is:

Cash Flow from Operations

In this section, you’ll get a report of the cash listed on the income statement. Some of the items included here are accounts payables, accounts receivables, and income taxes payable. Any changes to your current assets or liabilities are also recorded here.

Cash Flow from Investments

This section shows any cash flow related to the purchase and sales of long-term investments such as fixed assets. This includes plant, equipment, and property. Other items listed here are vehicles, buildings, and furniture.

Cash Flow from Financing.

Equity and debt transactions are reported in this section. Examples of cash flows included here are the sale or repurchase of stocks and bonds, payment of dividends, and cash received from a business loan.

Analyzing Your Company’s Cash Flow

While it’s a good start to have a cash flow statement on hand, you also need to understand it for it to be useful. Your “net operating cash flow” is considered your cash flow from operating activities. There are also several ratios that can help you analyze your cash flow and identify potential trouble spots.

Operating Cash Flow/Net Sales

This formula gives you a ratio that essentially tells you how much cash you are generating for every dollar of sales. While the average will vary by industry, a higher ratio figure is better than a lower one.

Free Cash Flow (FCF)

You can figure this by subtracting your capital expenditures from your net operating cash flow. This tells you how efficient your business is at generating cash. At a minimum, this should be a positive figure.

It’s a common misconception that a company can’t have cash flow issues if it is turning a profit. This simply isn’t the case. Businesses have gone under due to cash flow problems while still reporting a profit. This is one of the main reasons why it’s essential to focus on maintaining a healthy cash flow.

If you want to avoid the most common cause of small business failure (financial issues), you should understand your cash position. Consult with your accountant about ways that you can improve your cash flow. If you need trusted financial guidance for your business, find out how Chicagoland CPAs can help.