Interpreting your Statement of Cash Flow
There are three critical parts to a company’s financial statements.
The Balance Sheet – A one-time snapshot of the company’s assets and liabilities.
The Income Statement (Profit and Loss Statement) – This indicates the businesses income and expenses during a given time frame.
The Cash Flow Statement – This is a corporate checkbook that reconciles the Balance Sheet and the Income (P&L) Statement. It accounts for the company’s cash transactions (income and expenses) and it shows whether all of the revenue booked on the income statement have been collected.
What is Cash Flow?
Cash flow is the movement of money in and out of the business. Money that comes in is also referred to as “Inflow” or Income. Money that goes out of the business for expenses, purchases, overhead, debt repayment is referred to as “Outflow” or Expenses.
The business’ cash flow is how money balances between these two - Income and Expenses or Inflow and Outflow. Ideally, you want to maintain enough cash on hand to cover your operating expenses, as well as a savings to cover unexpected expenses along the way.
A business’ cash flow analysis doesn’t look solely at what is coming in and what is going out. It looks at the whole picture, and it considers non-cash assets as well as expenses to determine the profit amount. The cash flow statement includes three parts:
Operating Activities – This covers the basic income and expenses. This is the most important part and shows you how the cash was generated from products and services. This is the section that correlates most to your Income Statement.
Investment Activities – The inflows and outflows that result from purchase and sales of business investments, which may include assets or equipment. This is outside of the primary business activities of selling products and services.
Financing Activities – This would include anything that has been financed, either receiving a loan payment or repayment of a loan. This summarizes cash from raising, borrowing, or repaying capital.
At the bottom of the cash flow statement, you see the reconciliation with the Balance Sheet. It shows the beginning cash, plus the cash from the operating activities, minus the cash from investing activities, minus the cash from financing activities. That must equal the ending cash, which should reconcile with the Balance Sheet.
Cash Flow vs. Profit
Cash flow is not the same as profit. It isn’t uncommon to have these two terms confused because they seem very similar. Remember that cash flow is the money that goes in and out of the business.
Profit is specifically used to determine a company’s financial success or how much money it makes overall. The Net Income at the end of the Profit and Loss statement is the amount of money that is left over after the company has paid off its obligations.
Why does cash flow matter?
If your cash flow is not healthy, you could go out of business. Even if you are making more money than you are spending (a positive Net Income on your Income Statement), the timing of your cash inflow can impact the viability of your business. This is why it is important to consistently invoice your clients, pay attention to months when you know you have large expenses, and set aside savings if you are tempted to overspend once you’ve received a large payment.
Summary
Cash Flow is the ins and outs of funds through the business. Profit is whatever is left after subtracting a company’s expenses from its income.
