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Mark’s technology company was hiring like crazy. Their growth was through the roof. Then the penny dropped. It seemed like it came out of nowhere. A few key clients were causing overdue invoices. Suddenly, money was leaving the company faster than it was coming in. Monitoring his cash flow statement had been the furthest thing from his mind… until he experienced his first cash flow crisis.
Cash flow is one of the main reasons businesses fail. 82% of small businesses fail due to cash flow problems. None of these businesses planned to make a mistake by overlooking the importance of a cash flow statement. They were all doing what they thought was best — taking care of business.
What is a cash flow statement?
A cash flow statement is an analysis that shows how much cash is moving in and out of a business during a given period of time. One of the “big three” financial statements for any business, a cash flow statement both pulls from and supplements the information in your balance sheet and profit and loss statement (income statement). A cash flow statement shows how changes in the balance sheet and profit and loss statement affect the inflows and outflows of funds for a business.
What’s included in a cash flow statement?
A cash flow statement is generated from an analysis of the revenues and expenses in three main areas:
- Operating activities — How much cash you made or spent to produce the goods and services you sold.
- Investing activities — How much cash you used or made through buying or selling capital investments, like land or equipment.
- Financing activities — How much cash flows in and out to business loans or other funding transactions.
The amount of cash a business earns or spends on each of these activities is then summarized into an opening and closing cash balance. The summary of the cash movements from all three activities is the net cash movement or total change in the company’s cash position.
If the closing balance is greater than the opening balance, then you have a positive cash flow. On the other hand, if the closing balance is lower than the opening balance, your cash flow is negative.
If, at this moment, you’re feeling like you’re holding an Allen key and trying to assemble European flat-packed furniture, take a deep breath. The above is a top-level overview. To show how each of the activities is broken down and combined to create a cash flow statement, we’ll go through each one below.
Cash Flow from Operating activities (CFO)
Operating activities are all the functions related to producing or providing a company’s product or service. This includes inventory, accounts receivable, payroll and related taxes, like sales tax. One of the benefits of examining CFO activities and comparing them to net income is that it shows how well a business manages its operations. If everything is going to plan, then your CFO will be positive. A negative CFO could come from any number of inefficiencies ranging from pricing issues to outstanding invoices.
Another reason why CFO is so important is that it’s also the main way that small to midsized businesses finance themselves. In other words, this is where your “spending money” comes from.
Recording the CFO in a cash flow statement can be done either by the direct or indirect method.
- The direct method uses the cash-based system of accounting that only tracks payments that were actually made or received by the business.
- The indirect method uses the accrual system of accounting where payments are recorded before they’re received by the company.
If you’re not familiar with accounting methods, here’s what you need to know: Cash-based and accrual are the two most common accounting systems. This also means that both the direct and indirect methods of calculating operational cash flow are valid. Ultimately, the choice comes down to what’s best for your business.
Some businesses choose the direct method because it leaves out non-cash transactions. Other businesses choose the indirect method because they can pull numbers directly from their balance sheets and profit and loss statements.
Cash Flow from Investing activities (CFI)
The second area, cash flow from investing activities covers purchases or sales of items that are considered long-term investments. Investing activities can include business equipment, buildings real estate and even securities. Again, a lot depends on your business, your industry, stage of business and other factors.
One of the reasons the inflows and outflows from investing activities are separated is that many of these purchases are considered capital items. At tax time, large purchases are depreciated over time, meaning you can only claim a certain percentage of the costs over a specific number of years. Funds invested in purchases are considered outflow and funds made from the sale of investments are inflow.
When reviewing CFI, remember it’s a long-term plan and the results are taken into consideration along with other activities. For example, if your business is in growth mode, you may be investing in equipment and other capital to help fuel further growth.
Cash flow from financing activities (CFF)
Depending on the size and structure of a business, cash from financing can include the size and payment amounts of business loans or the payment of dividends for incorporated businesses. For startups, this would include fundraising as well as any amounts paid to investors.
Using a small business loan as an example, the money your business receives from the loan is counted as an inflow, while the loan payments are outflows. A business’ CFF is used as a variable for measuring equity (ownership) as well as lending risk. For example, if you have a lot of debt, but it’s not being used to fuel growth or produce results, you will want to start thinking of ways to pay down the debt. Similarly, an outside business or analyst might also highlight a high level of debt as a consideration or concern.
How often should you run a cash flow statement?
Usually, it’s best to check your cash flow statement every month. But if your business’s cash situation changes a lot or you’re just starting out, it might be smart to look at it every week. Doing this regularly helps you see patterns, like when you have more or less cash. Think of it like teaching a kid to eat veggies – it’s good for your business in the long run, even if you need to push yourself a bit at first to do it regularly.
What can a cash flow statement tell you about your business?
By identifying and recognizing patterns in your cash flow through regular analysis, you’ll be better able to predict or prevent challenges, like finding yourself low on cash right before running payroll or experiencing a negative cash flow when an invoice payment is running late.
If you see a cash flow gap coming, you can take measures like finding short- or long-term financing, working with a vendor to see if you can extend a invoice payment terms or, if necessary, adjusting labor costs. Keeping track of your accounts receivable is crucial, as outdated payment methods like checks and regular ACH can delay payments by up to 10 days. Offering faster payment options to your vendors, like instant payments or same-day ACH, can help you manage cash flow more efficiently.
When your cash flow is positive, you’ll also be in a better position to plan your growth by timing when you choose to act on a strategic decision, like purchasing new equipment, launching a new product or hiring more staff. Understanding how your cash flow works gives you insights into the financial strength of your business. It tells you how you can improve your cash flow management strategies.
Take control of your cash flow with Forwardly
Start using Forwardly today to make managing your cash flow easier. Forget about waiting for payments or being unsure about when they’ll come in – with our Instant Payments and free same-day ACH transfers, you’ll get your money faster. Plus, our system can handle your bills automatically and sync up with your accounting software like QuickBooks Online and Xero, saving you a ton of time.
With Forwardly, you can get paid in just 60 seconds for a small fee of 1% (capped at $10), ensuring your cash flow stays steady. And you won’t have to pay extra for bill payments or Same-Day ACH transfers – they’re included for free. We’ll even help you with cash flow forecasts, so you can stay on top of your finances.
Take control of your cash flow with Forwardly at no monthly cost – we’re your partner in building a successful business.
