The cash flow statement is the most important and insightful financial statement for any organization. This financial statement shows how management is generating and spending the cash of an organization over time.
Unfortunately, most small companies do not have a good cash flow statement. The reason this key financial statement is missing is that generating an accurate cash flow statement is a manual process. All accounting systems are set up to automatically generate a balance sheet and income statement, on an accrual basis, based on the transactions that are entered, but not a cash flow statement. A good accountant can pull together an accurate cash flow statement, but it takes time, knowledge of the business, and access to the transactions within your balance sheet and income statement.
The cash flow statement is organized into three sections: Operating, Investing and Financing.
The Operating section takes the organization’s net income and adds back any large non-cash items, which is usually depreciation and amortization expense. The depreciation and amortization amounts are the costs of larger and long-life assets on your balance sheet [think property, plant, and equipment] that are being expensed over their useful lives. Additionally, the Operating section evaluates how your organization is managing their working capital, which is primarily their accounts receivable and accounts payable balances. This provides great insight in assessing the effectiveness of management, for example if Accounts Receivable shows as a negative amount, that means the organization has more cash tied up on their receivables than in previous periods. This could be indicative of future collectability issues or poor cash collection efforts of customer receivables. Ultimately the most important line is the “Net Cash provided by or (Used for) Operating Activities” as this demonstrates whether the operations are generating cash or consuming cash.
The Investing section shows the money that the organization has put back into their business. Normally you will see in this section the amount spent on large capital purchases such as buying new equipment or facilities. The investing section also shows if the company is liquidating any assets such as selling off equipment or land. This is especially important for those businesses that are very capital intensive and evaluating how management is maintaining or building their long-term property, plant, and equipment assets.
The Financing section shows what is happening in the business regarding their debts and investors. Organization’s will show all debt repayments as well as any new debt that was obtained during the period. Also, any payments to investors such as dividends, as well as any issuance or repurchase of company stock.
The total of the three sections (Operating, Investing, and Financing) will demonstrate the change in and organization’s cash balance during the period being evaluated.
The cash flow statement demonstrates how management is doing managing their working capital, the impact of their operations on cash, as well as the investments being made into the business along with how debt and investor activities are affecting cash. All these activities are critical in evaluating the status of the business and managements stewardship of the business’s resources. If I only had time to evaluate one financial statement for an organization, it would be the cash flow statement.
Mark Snyder is an Area President with FocusCFO based in Cleveland, OH.