Thoughts About The Cash Flow Statement

Differentiating between one-time and ongoing expenses is key. One-time costs include obtaining assets like equipment or machinery, but may also involve licenses or permits for certain businesses. These costs usually occur during the startup phase or when a business expands. Expenses that must be paid monthly or periodically (like quarterly) represent ongoing costs. Variable costs, however, will fluctuate according to factors like output, production, or consumption. Why separate assets and expenses? Expenses are deductible against income, so they reduce taxable income. Assets, on the other hand, are not deductible against income.

Changes in your company’s cash flow typically have an impact on your day-to-day job. It’s a good idea to stay up to date with the cash situation, because it may affect your budget for the upcoming year. When cash is tight, you will probably want to be conservative in your planning. When it’s plentiful, you may have an opportunity to propose a bigger budget. Note that a company can be quite profitable and still be short of cash as a result of making a lot of new investments, for example, or having trouble collecting receivables.

You may also have some influence over the items that affect the cash flow statement. Are you responsible for inventory? Keep in mind that every addition there requires a cash expenditure. Are you in sales? A sale isn’t really a sale until it is paid for…so watch your receivables. There are three big reasons for understanding the cash flow statement.

First, it will help you see what is going on now, where the business is headed, and what senior

management’s priorities are likely to be. You need to know not just whether the overall cash position is healthy but specifically where the cash is coming from. Is much of it coming from regular business operations, rather than from lenders or investors? That’s a good thing—it means the business itself is generating cash. Is investing cash flow a sizable negative number? If it isn’t, that may mean the company isn’t investing in its future. And what about financing cash flow? If investment money is coming in, that may be reason for optimism—or it may mean that the company is desperately selling stock to stay afloat. Looking at the cash flow statement generates a lot of questions, but they are the right ones to be asking. Are we paying off loans? Why or why not? Are we buying equipment? The answers to those questions will reveal a lot about senior management’s plans for the company.

Second, you affect cash. Most managers focus on profit when they should be focusing on both profit and cash. Of course, their impact is usually limited to operating cash flow—but that’s one of the most important measures there is. For instance:

  • Accounts receivable. Factors such as customers’ satisfaction with your service, their relationship to your salespeople, and the accuracy of your invoices all help determine how customers feel about your company, and indirectly influence how fast they are likely to pay their bills. Disgruntled customers are not known for prompt payments—they like to wait until any dispute is resolved.
  • Inventory. If you’re in engineering, do you request special products all the time? If you do, you may be creating an inventory nightmare. If you’re in operations and you like to have lots in stock, just in case, you may be creating a situation in which cash is just sitting on the shelves, when it could be used for something else.
  • Expenses. Do you defer expenses when you can? Do you consider the timing of cash flow when making purchases? Obviously, we’re not saying it’s always wise to defer expenses; it’s just wise to take into account what the cash impact will be when you do decide to spend money.
  • Giving credit. Do you give credit to potential customers too easily? Alternatively, do you withhold credit when you should give it? Both decisions affect the company’s cash flow and sales, which is why the credit department always has to strike a careful balance.

The list goes on. Maybe you’re a plant manager, and you are always recommending buying more equipment, just in case the orders come in. Perhaps you’re in IT, and you feel that the company always needs the latest upgrades to its computer systems. All these decisions affect cash flow, and senior management usually understands that very well. If you want to make an effective request, you need to familiarize yourself with the numbers that they’re looking at.

Third, managers who understand cash flow tend to be given more responsibilities, and thus tend to advance more quickly, than those who focus purely on the income statement. You could go to someone in finance and say, “I notice our DSO [days sales outstanding] has been heading in the wrong direction over the last few months—how can I help turn that around?” Alternatively, you might learn the precepts of lean enterprise, which focuses on (among other things) keeping inventories to a minimum. A manager who leads a company in converting to lean thereby frees up huge quantities of cash. The general point here is that cash flow is a key indicator of a company’s financial health, along with profitability and shareholders’ equity. It’s the final link in the triad.

Understanding the difference between profit and cash is a key to increasing your financial intelligence. It opens a whole new window of opportunity to make smart decisions. For example: 

  • Finding the right kind of expertise. The two situations described above require different skills. If a company is profitable but short on cash, then it needs financial expertise— someone capable of lining up additional financing. If a company has cash but is un- profitable, it needs operational expertise, someone capable of bringing down costs or generating additional revenue without add- ing costs. So financial statements tell you not only what is going on in the company but also what kind of expertise you need to hire. 
  • Making good decisions about timing. Informed decisions on when to take an action can increase a company’s effectiveness. 

The ultimate lesson here is that profit and cash are different—and a healthy business, both in its early years and as it matures, requires both.

For more thoughts on the Balance Sheet, view the free video entitled The Financials – Managing Your Business Session 1 Understanding Key Concepts and read a free sample of the new book “Small Business Thoughts Real-Time Strategic Planning“.

Copyright ©John Trenary 2022

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