How to understand a cash flow statement

Published · 4 min read

More businesses fail because of poor cash flow than any other reason, which is why you to need understand the basic principles. A cash flow statement will help to give you clarity.

One of the biggest challenges you face as a business owner is understanding and managing your cash flow. The good news is that a good grasp of what cash flow means will help you build a successful and profitable business.

Let’s think of cash as oxygen. If you don’t get enough oxygen, you stop breathing. If you don’t get enough cash, your business stops breathing. It’s vital that you grasp the basics, then create yourself a cash flow statement to use as your business bible. (It’s best use good accounting software for this as it saves hours pounding away on spreadsheets.)

Cash flow rules to follow

Rule one of cash flow is that, in any given month, you need more cash coming in than going out. You’d be surprised how many times people don’t get that right. Rule two is that cash needs to come in at the right time.

Following the rules is easy to do. A cash flow statement will show how much you are down (losses) or how much you are up (profits). Create a 12-month spreadsheet and work out what you intend to sell and when you expect payment.

In an adjacent column, work out what you need to pay and when. For example, you may have a cyclical business that does well over the Christmas period. November to February is when most of the cash is pouring in. Let’s also assume that your staff costs are constant.

However, you pay rent on your premises, and maybe some bank financing, every three months. Most of the cash was taken over Christmas but there are large payments due in March. Overcoming this requires planning. You need to ensure you have enough from the good times to pay your commitments in leaner times.

Business ups and downs

You rarely get a cash flow that is constant. Instead, you quickly realise that cash flow is like a wave, with ups and downs. What you must avoid is having a down period when payments are due because then you have problems. This is when a cash flow statement becomes crucial to your business.

If you project what you intend to sell over 12 months, and project what you intend to pay out on behalf of your business for every month, you will build a clear picture of how your business operates.

“A cash flow statement will show the ins and outs of cash flow in your business” – Nicky Larkin

You can then compare this with previous years, or six-month periods, and see where the pressure points come within your business. Anticipating pressure points will save you a lot of heartache because you will see where you need most of your cash to pay your bills.

Potential major financial hole

A properly constructed cash flow statement will give you superb visibility for your business – one that you can use to your own advantage.

Let’s suppose you know how your business will fare in any given month, but you are invoicing every 30 days and on delivery. This could mean that you won’t get paid for six weeks.

However, in the fifth week, you need to pay a major bill, resulting in a potential major hole that must be filled with money from somewhere. If you can’t find it from existing resources, you might need to speak to your bank for a short-term facility.

An accurate cash flow statement is invaluable in these situations because it allows you to spot potentials pitfalls and take the necessary steps to keep your head above water.

A cash flow statement will help you keep on top of the numbers for your business
A cash flow statement will help you keep on top of the numbers for your business

How a cash flow statement can help

Nicky Larkin is the founder and managing director of the Reading-based Goringe Accountants. On the topic of the cash flow statement, she says: “Cash flow statements are a snapshot of your business, of how much cash you have available and how liquid it is.

“After all, cash is the reality of your business. You could have a growing business with huge amounts of profit, but if it hasn’t got cash to sustain that you won’t be able to achieve your goals.

A cash flow statement will show the ins and outs of cash flow in your business. It will show the most important thing, which is cash coming in from your clients.

“It will also show other ins from your business, which will be any investment you have from your shareholders, and any loans from your banks or other stakeholders who are willing to loan you money.

“It also shows the outgoings, such as your normal suppliers, rent, labour cost, your direct cost for goods, and all overhead costs. It also shows your tax and finance payments. A cash flow statement is, then, the reality of cash coming in and going out of your business.

“What you’re trying to make sure is that you always have more inflows than outflows so that you can maintain your business and you can meet your cash requirements. Therefore, it’s important to remember what cash flow statements are telling you. Remember that cash is reality, profit is sanity.”

Staying in control

Cecile Mills is the founder of Coconuts Naturally, an organic dairy-free ice cream company in Cornwall. After finishing university, she joined the Marks and Spencer graduate scheme in store management and later joined Oliver Bonas as retail operations manager.

Cecile adopted a vegan, raw-food diet and decided to make ice cream for herself and her family. This broadened to friends and eventually became the basis for her business. She moved from Brighton to Cornwall and started her ice cream company.

Cecile sees cash flow as a key indicator for the health of her business, which she divides into four main customer segments. The business has relatively fixed costs, mainly from outsourced manufacture.

She says: “All those assumptions just go into our formula on our cash flow forecast and then it generates our overall predicted gross profit. There’s a lot of sense checking and once we’re happy with it, we think this looks doable, and feels right.”

By using a cash flow statement, Cecile maintains a good grip on her business via strong systems and core business information. The cash flow statement is like an oar – it helps you ride the waves through the ups and downs and, most importantly, gives you control over the success of your business.

The Art of Being Paid

Chasing invoice payments doesn’t have to be painful. Use this kit to answer a few questions about your customers so you understand their payment drivers, then read our advice on how to flex your style for each, calling techniques and much more.

Download the kit

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