Knowing how to read a cash flow statement is a valuable skill for any businessperson. Whereas income statements and balance sheets provide considerable insight into a company, the cash flow statement gives a clear picture of its cash position.
A simple cash flow statement for a business provides information about the cash that comes into and goes out of the organization. The first section records all sources of income. These are cash inflows, or cash receipts (not to be confused with receipts for purchases). The next section reports cash outflows, or necessary disbursements: insurance and interest payments, supplies, wages, salaries, and so forth. Most cash flow statements break down inflows and outflows according to whether they are related to operations, investing, or financing. The last section shows the net change in cash flow. This tells the entrepreneur whether the business has had a positive or negative cash flow. You can have all the sales in the world and still go out of business if you do not have enough cash flowing in to cover your cash outflows.
The Cash Flow Equation
Cash Flow = Cash on Hand + Cash Receipts − Cash Disbursements
Inflows and outflows of cash are divided into three categories:
Operations: Money used to run the business.
Investment: Money going into and out of investments in the business, such as equipment, vehicles, or real estate.
Financing: Money used to finance the business (debt and equity).
Forecasting Cash Flow: The Cash Budget
As you get your business off the ground, and even after it has been operating for many years, you should prepare cash flow projections to make sure there is enough money to pay the bills. In the beginning, monthly—or even weekly—cash flows are in order. There are two steps to forecasting cash flow receipts:
Step 1: Project cash receipts from all possible sources. Remember, orders are not cash receipts, because they may not become cash. Some may be cancelled and some customers may not pay. Cash receipts are checks that have cleared, or credit card payments, or cash itself. Plus, note the assumptions you are making to arrive at these figures, so that others can understand the logic behind the statements.
Step 2: Subtract expenditures that would need to be deducted to meet this level of cash receipts. Cash expenditures are only those expenses you will actually have to pay during the projected time period.
You know that any projections will not be completely accurate, but you should create them to the best of your ability and review and update them routinely. They will be useful for anticipating any shortfalls, so that you can make adjustments to costs, push for increased sales, and/or arrange short-term financing, as needed. Learn about different things related to cash flow statement only at LSBF.