Unraveling the Power of Cash Flow Statements for Small and Medium-Sized Businesses

As small or medium-sized business owners, you have to wear many hats. And while the challenges that come with entrepreneurship can be rewarding, the financial aspects can be complex and, at times, downright confusing. The need for a strong understanding of financial statements, such as cash flow statements, is critical for making informed, strategic business decisions.

What is a Cash Flow Statement?

A cash flow statement is one of the main financial statements that businesses use to evaluate their financial performance and make strategic decisions. It provides vital information about a company's cash receipts (cash inflow) and cash payments (cash outflow) over a specific period. This statement allows stakeholders to understand how a company's operations are running, where its money is coming from, and how it's being spent.

To that end, a good cash flow statement typically is divided into three main sections: operating activities, investing activities, and financing activities. 

Where Is My Cash Going? Cash Flow Statements Provide Essential Insights

The cash flow statement, often overshadowed by the income statement and balance sheet, is a pivotal tool in understanding the liquidity and financial health of your business. As Rich Martorano, CFO at FocusCFO, puts it, "Flaws and concerns can be masked within a condensed Income Statement and Balance Sheet, whereas a cash flow statement, which showcases liquidity and the sources and uses of cash, can provide keen insight into how a business is operating.” He explained that a business owner once approached him and admitted, “I see on paper that we are making a profit but I don’t know where my cash is going.” Martorano advised the business owner to take an informed look at the cash flow statement alongside a solid cash forecasting template. It provided a credible base to formulate strategies for growth and profitability and the client quickly adopted new reporting and review practices as a result.

A case in point comes from Anthony Griffin, another CFO at FocusCFO, who used the cash flow statement to guide the business partners through the next year's budget. By strategically organizing the cash flow statement, he made the data more accessible and understandable, which led to more informed decision-making.

The Significance of Cash Conversion Cycle

The cash conversion cycle, the time it takes for a company to convert its investments in inventory and other resources into cash flows from sales, plays a crucial role in managing operations and working capital. Martorano emphasizes that a shorter cash conversion cycle is often a sign of efficient cash flow movement. 

“Cash conversion cycles will vary based on specific industries and market conditions, so a company’s number of days in the cash conversion cycle needs to be kept in perspective particularly when benchmarking peer performance.”

However, understanding the context of your business is key. “Cash conversion cycles will vary based on specific industries and market conditions, so a company’s number of days in the cash conversion cycle needs to be kept in perspective particularly when benchmarking peer performance,” says Martorano.

Griffin agrees on the importance of context, adding that the cash conversion cycle's importance increases during periods of rapid sales growth when accounts receivable and payable are growing. “I like to include the Days Sales Outstanding and Days Payable Outstanding in the operating metrics so we can see the favorable or unfavorable cash flow at a glance,” adds Griffin.

Common Mistakes and Lessons Learned

Despite the value of cash flow statements, mistakes in their creation, analysis, and use can be costly. Griffin outlines common mistakes: businesses often make the mistake of having unrealistic or inaccurate analyses of cash flow statements, or fail to equip the leadership team with the understanding and tools to execute prescribed goals.

John Tate, CFO at FocusCFO, shared an example from his career, where an opportunity for making a strategic investment was missed due to overemphasis on current cash flow and underemphasis on the short-term market conditions – which had a temporary negative impact on the numbers.  By understanding that the current market conditions would be temporary and that the historical and forecasted trends were still strong and fundamentally sound, leadership would have seen the opportunity through the short-term fog. “The moral of the story: review the numbers, respect the numbers, but don’t use the numbers as an excuse to ignore the underlying business reality and conditions within which the numbers exist."

Managing and interpreting cash flow statements can be a daunting task for many business owners, falling outside of their expertise or interest. This is where a Fractional CFO comes in. They can help you understand your financial position better, make more informed business decisions, and avoid common pitfalls. 

As your business grows, the complexity of your financial landscape grows with it. Engaging a fractional CFO can help bridge the gap in financial expertise, enabling you to focus on what you do best: running your business. 

Ready to learn more about how a fractional CFO can help with your cash flow needs? Schedule a complimentary 60-minute assessment to explore the possibilities and ensure your business's financial future remains bright.