Most business owners think of cash flow as the "big picture" of their business. We all understand that cash flows in both directions – in and out – with most of us being more interested in the "in" than the "out". Businesses thrive when there is enough in cash from business activities to cover all expenses and be "cash-flow positive,” but sometimes that inflow has to come from financing or sales of assets.

Understanding the past, current and future direction of cash flow can help you make critical decisions about your company. And that’s where knowing how to read a cash flow statement can really come in handy.

 

What a cash flow statement can tell you

A cash flow statement serves as a snapshot of the amount of cash and cash equivalents entering and exiting your business.

The statement indicates the extent to which a company can produce or attract enough income to cover its expenses, including taxes, debts and other obligations. Your cash flow statement provides insights not only for you, the business owner, but also for others interested in doing business with the company, such as a potential partner, supplier or investor.

It can be difficult to track where the cash comes in and goes out if your customers pay for your products and services almost entirely in cash with no paper or electronic invoices and receipts. Fortunately, your cash flow statement can help remove any confusion and give you a much clearer picture of your cash position while even providing insights into your operations in general.

How to calculate cash flow

The cash flow statement includes activities from three main areas:

1. Operations
2. Investing
3. Financing 

While the cash flow statement is a key component of a company's financial reports, it is different from the balance sheet and income statement because it does not include the amount of future payments captured as credits. That's why cash flow differs from net income, which on the income statement and balance sheet includes both cash sales and sales made on credit. A  cash flow calculator can help you capture the data you need from each area of your business. 

How Cash Flow Is Calculated

Cash flow is calculated from information found in both the balance sheet and income statement. Adjustments to net income found in these documents need to be made by adding or subtracting differences in revenue, expenses and credit transactions taking place from month to month (or whatever period you're looking at). 

These adjustments are made because non-cash items can appear as net income and are reported in the income statement. Similar non-cash items can appear as total assets and liabilities in the balance sheet. Many of a business's transactions do not involve actual cash, so several items have to be taken from these financial documents and evaluated to determine whether they can be used to calculate cash flow from operations.

Examples of non-cash items include deferred income tax, employee stock-based compensation and depreciation and amortization (such as a large asset you bought for your business, like machinery). Your accountant can help you determine which non-cash items would stay on the balance sheet and income statement and which would make it to your cash flow statement.

Inventory Value and Cash Flow

Spending more on inventory is a sign that you have spent more money to purchase more products or raw materials. If the inventory was paid with cash, the increase in the value of inventory is deducted from net earnings. Conversely, a decrease in inventory would be added to net earnings. This inventory can also be seasonal; your business purchases special holiday-themed goods in September—affecting cash flow for the month of September—but you hope to sell this inventory in the month of December.

 

Investing

Cash from investing might include the company purchasing or selling an asset, such as a commercial property or a large piece of equipment needed to run the business. Cash from investing activities might also include loans made to partners or vendors. Essentially, cash from investing means changes in buying or selling equipment, assets or investments.

If you use cash to buy equipment or real estate, it's called a "cash out." The reverse—when you receive cash from selling an asset—you are "cash in." 

Financing

Cash from financing includes the cash you receive as a loan from a bank or as capital raised in exchange for shares of ownership of your company from investors. If you pay dividends to investors or repay the principal of a loan to a lender, this cash is considered a financing activity.

When to perform a cash flow forecast

A cash flow forecast is generally run once per month. However, some types of businesses might need to keep track of it much more frequently, perhaps on a weekly or even daily basis. 

Business owners who are about to make a big change to their business—perhaps moving into a larger space, using a new supplier or seeking capital from new lenders or investors—would also be advised to perform a cash flow forecast to determine how these changes are expected to affect the business.

How to use a cash flow statement to guide your decisions

Cash from financing includes the cash you receive as a loan from a bank or as capital raised in exchange for shares of ownership of your company from investors. If you pay dividends to investors or repay the principal of a loan to a lender, this cash is considered a financing activity.

As a simple way to think about your business's cash flow, do the following:

• Look at your total sales at the end of the month.
• Add up all of the expenses you made in addition to those that you still need to pay for.
• The difference is what your business needs in income in order for you to break even.  

Of course, as a business owner, you probably want to do more than simply break even. If you have a particular profit margin in mind, consider this when figuring out what your optimal cash flow must be. 

Further, you might notice a shortage during one month, or perhaps several. You most likely do not want this to be recurring, because if you get further and further behind it will be hard to turn cash flow positive.

New businesses often face this cash crunch. Expenses are high and cash from customers might not be coming in as quickly as you might have hoped. However, sources of cash in the form of a line of credit—cash from financing activities listed above—will get a new business into a positive cash flow situation.

As such, new businesses might need to calculate their cash flow much more frequently than those that are established. Figuring out the dramatic effects of small changes in payments to suppliers or prices charged to customers can help entrepreneurs have a much stronger picture of their cash flow and might even help them figure out strategies they hadn't thought about when first deciding to launch their business. 

For example, let's say you want to open up a small yoga studio. You aren't sure how many clients you need to break even, but you do know that the typical yoga customer in your local market area is comfortable paying a monthly subscription of $100.  Your anticipated total monthly expenses will likely include rent ($2,000), utilities ($300), salaries for your instructors ($5,000) and advertising and marketing ($2,000). You can figure out how many customers you would need to break even, as part of your cash flow analysis:

Income = Expenses (Breaking even)
(Number of customers) * $100  = $2000 + $300 + $5000 + $2000
(Number of customers) * $100 = $9,300
Number of customers = $9300/$100
Number of customers = 93 

You would need 93 customers to break even before you even open your doors. You can continue to calculate your cash flow as you have a better understanding of your expenses and as you acquire more customers.

Take the next step

Unsure about your cash flow? Curious to know how to get cash flow under control? The financial solutions providers at National Bank of Arizona are here to help.

Contact us today for to get the financial insights and treasury management support you need from our team of experienced professionals.

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