Neil Patel

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What is a cash flow statement? Cash flow can make or break your business. The reason for this is that if the money doesn’t come in at a steady or fast enough pace, then there is not enough to maintain the business, which could end up failing.

Ideally, you want to have a positive cash flow, which means that more money comes in than goes out. If your company has a positive cash flow, it will be able to pay its expenses and invest in growth. A negative cash flow indicates you’ll need to locate another source of income to pay for your commitments and fund any growth. This is why it is critical that you understand how to use a cash flow statement.

This is also critical in securing funding and valuing your business.

In this article, we will explain what a cash flow statement is, what the statement should include, the different methods used, and show you how the statement can help clear any bumps in your business.

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    What Does a Cash Flow Statement Show You?

    Cash flow statements are types of income statements that show the cash inflow and outflow from a business. A cash flow statement is an important financial statement for any business because it not only shows what has happened but also helps explain why. It can help a business look forward to predicting whether there will be enough money to support its future plans.

    It also lets you know if there are any problems with the cash flow situation that need to be addressed immediately.

    A cash flow statement shows you:

    • How much money was brought in from sales during a specific time period?
    • How much money does your business spend on operating expenses and investments in assets like property, plant, and equipment?
    • How much money was paid out as dividends to shareholders or creditors?
    • What happened to any excess cash that was left over after all these transactions were completed?

    The cash flow statement shows how much cash was received and spent over a period of time. It also shows how much cash was generated by operations and by financing activities during that same period.

    Keep in mind that in fundraising, cash flows projections and statement play an important role in convincing investors to fund your business. In this regard for a winning pitch deck to help you here, take a look at the template created by Silicon Valley legend, Peter Thiel (see it here) that I recently covered. Thiel was the first angel investor in Facebook with a $500K check that turned into more than $1 billion in cash.

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    The Importance of a Cash Flow Statement

    The cash flow statement is a way to measure your company’s liquidity and solvency. It’s especially important when you’re looking at venture capital, going public, or borrowing because it tells you how much money is actually going through the business and whether it is profitable, or insolvent.

    It’s also important because it shows you where your company stands financially, so you can make decisions about whether or not to take on additional debt or equity financing. Or where you need to patch up the holes.

    You can ensure that your business runs smoothly on a daily basis by balancing the money that comes in and the money that goes out. At the same time, by keeping this balance, you can accumulate reserves to weather sales peaks and troughs, unexpected expenses, and fund growth.

    Cash Flow Statement vs. Income Statement

    To understand a cash flow statement, you must first understand the differences between an income statement and a cash flow statement.

    An income statement is a summary of your company’s revenues and expenses over a set period of time (usually a year). It’s usually given in the form of net income, which is calculated by subtracting expenses from revenues. This is important because it allows you to see whether or not your business is earning money while operating.

    A cash flow statement, however, is used to measure the movement of cash within your business over a set period of time (usually one year). It shows how much cash went into and out of your business during that time period, and it also shows how much came in as profit or loss during that same period.

    Sometimes, especially for startups, it is more important to ensure cash is available on time to pay workers and bills, than the gross amount of income, or sales being made.

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    Components of a Cash Flow Statement

    Generally, there are three components of a cash flow statement:

    1. Operating income
    2. Investment income
    3. Financing income

    Let’s take a closer look at each:

    Cash from operating activities

    Cash from operating activities is the amount of money your business brings in from its day-to-day operations. This is your sales.

    Cash from operating activities does not include transactions that fit into one of the following categories:

    Cash from investing activities

    Cash from investing activities is the money you get from investing in other companies or assets. It’s usually listed as a separate item on your cash flow statement, and it can be one of the most important portions of your statement to understand.

    Cash from investing activities can include things like:

    • Buying stock in other companies
    • Investing in real estate (like purchasing land)
    • Buying fixed assets like machinery
    • Acquiring patents or other intellectual property

    Cash from financing activities

    Cash from financing activities is the money that a company or organization receives from loans, investments, or other sources of financing. This section of the cash flow statement shows the amount of cash received from new debt, equity capital, and other financing sources.

    What are the Different Accounting Methods of a Cash Flow Statement?

    Learning how to understand a cash flow statement is an essential skill for anybody who wants to have a thorough understanding of a company’s finances.

    There are two accounting methods that can be used in a cash flow statement: the indirect flow accounting method and the direct cash flow accounting method.

    Indirect flow accounting method

    The statement will begin with a company’s net income if the indirect method is used. The adjustments required to convert accrual accounting net income to cash flows from operating activities are then applied to the net income. The following are some of the most common modifications when using the indirect method type:

    • Add the increase in accrued expenses
    • Deduct the decrease in payable accounts
    • Add the drop in accounts receivable
    • Deduct the inventory increase
    • Add depreciation expenses

    Direct flow accounting method

    When using the direct accounting cash flow statement method, you wouldn’t use the net income as the starting point. You would instead use the cash amounts that were received and paid by the business. The following are some common scenarios of using the direct accounting cash flow statement method.

    • Money paid for goods/supplies
    • Money paid for interest
    • Money paid to staff
    • Money paid to suppliers
    • Money from clients

    Now that we know what a cash flow statement is, the importance of the statement, and the different components and methods used, let’s look at how you can use a cash flow statement to better understand your company’s financial health.

    Preparing a Cash Flow Statement using the Indirect and Direct Methods

    Indirect

    Here are the steps to follow when preparing a cash flow statement that uses the indirect method:

    • Start with the net income of the business. You can easily find this information on the business income statement.
    • Determine any profits and losses from investing and finance activity, e.g., gain from the sale of land or loss from the sale of equipment.
    • Calculate noncash changes in income, then deduct non-cash revenues.
    • Then, look at operating liabilities and assets. Take away any increases in operating assets and add any decreases in those same accounts. And for operating liabilities, add the increases and subtract the decreases.

    The formula for finding the indirect cash flow method is:

    Cash flow = Net Income + losses and gains from financing and investment + changes in operating accounts + non-cash charges

    Direct

    Here are the steps to follow when preparing a cash flow statement that uses the direct method:

    • Start with receipts from customers.
    • Deduct cash expenses, which may include research, development, administrative costs, and so on.
    • Deduct the total of taxes that were paid in cash.
    • Deduct the total interest that was paid by cash.
    • Deduct cash payments made to suppliers. This is your cost of goods and should be adjusted to changes in the inventory.

    The formula for finding the direct cash flow method is:

    Cash flow = Cash Receipts – Cash Taxes – Cash Payments – Cash Expenses – Cash Interest

    Signs that you have an Unhealthy Cash Flow Statement

    There are a number of things that can indicate a poor cash flow statement, but the most obvious one is a negative net change.

    Negative net change

    If you start with a positive amount and end with a negative amount, this suggests that your business is not operating in an efficient manner. This may be due to the fact that you are producing too much product, or because you are spending more money than you have coming in.

    Excessive short-term debt

    Short-term financing is a terrific way to solve cash flow problems, but if used carelessly, it may become a problem in itself. Finance has a cost – in fees, interest, one-time expenditures, and so on – that has the potential to undermine your cash and profitability. If your bank has rejected your credit and you are seeking short-term financing from several sources, you may overextend yourself and have a cash flow crisis.

    The company’s resources are not being used effectively

    To put it another way, they are not bringing in enough money to pay the expenses associated with their production or operation. This may be the result of a lack of innovative thinking on the part of the business or an inability to compete successfully with other companies operating in the same sector.

    Having a robust cash flow is critical when you’re trying to gain funding from investors. But, you should also know how to present financials to investors for a startup with no revenue. Not sure how to do that? Check out this video I have created explaining how that’s done.

    Signs that you have a Healthy Cash Flow Statement

    If you’re looking for healthy signs in your cash flow statement, here are some things to keep an eye out for:

    • A positive cash flow from operations. The amount of money you make from selling products or services should be greater than the amount of money you spend on operating expenses. If not, that’s a red flag that you might have some trouble ahead.
    • Multiple revenue streams. Businesses that rely only on one source of income may be riskier than those that rely on numerous sources of cash flow. One of the most prominent instances is having a physical shop as well as an eCommerce site to generate cash from distinct consumer bases. Diverse product or service offerings can also be a good indicator. As well as have a broad customer base, and recurring revenues.
    • You aren’t borrowing money from banks or other sources. If you are borrowing money to keep your business afloat, then that’s a sign that things aren’t going well enough for you to pay off debts without outside help (which means more interest costs).

    Tips for Maintaining a Healthy Cash Flow

    Here’s what you can do to improve your cash flow:

    Speeding up your cash inflows

    This will help ensure that more money comes into the business at a faster rate than usual. It’s important because if you have issues with speedily collecting payments from clients or suppliers, then this could cause problems later on down the road

    Process invoices on time

    If you’re not sending your invoices on time, the chances of getting paid are slim. The best way to avoid this situation is by setting up automated reminders in your billing software that will alert you when it’s time to send out your invoices.

    Keep an eye on what you spend

    If you notice that you’re spending more than usual, it could be a sign that something is wrong. Most people don’t actually know how much they spend each month, but if you start tracking your spending, it’s easier to see where the money is going, and where it’s not going.

    Plan ahead

    Planning is an excellent way to ensure the success of a business. To keep your business running smoothly, you must have both long-term and short-term goals. You can budget your costs for the next 12 months to ensure you have enough money to meet your responsibilities.

    Cut your costs

    Perform a cash flow analysis using your cash flow statement to discover if there are any recurrent costs that you could reduce. If you believe you need to minimize costs or negotiate payments, do so wherever possible.

    Conclusion

    Understanding a cash flow statement can be a little confusing at first, but it’s actually pretty simple once you get the hang of it. The best way to understand a cash flow statement is to break down the different sections and familiarize yourself with what those sections mean.

    A cash flow statement is an essential tool for any company to use in order to keep track of its cash flow. The cash flow statement can help you see where your business is making or losing money, how much money you are spending on things like loans and interest payments, and what types of expenses are eating up your profits. By using this information, you can make decisions about where to focus your efforts during the coming year.

    You may find interesting as well our free library of business templates. There you will find every single template you will need when building and scaling your business completely for free. See it here.

     

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    Neil Patel

    I hope you enjoy reading this blog post.

    If you want help with your fundraising or acquisition, just book a call

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