This Least Popular Financial Statement is Also the Most Valuable | USTaxAid

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This Least Popular Financial Statement is Also the Most Valuable

Written by Diane Kennedy, CPA on April 24, 2022

There are three financial statements that every business owner needs. The balance sheet reports assets, liabilities and equity as of a certain date. It tells the present. The profit & loss statement shows income and expenses for a specific period. It tells the past. And the statement of cash flows tells you which way your cash is flowing for three important categories. It tells the future.

Of these, your statement of cash flows is the most powerful. That’s because this statement foretells where your greatest risk is and whether you are even going to be in business next year.

Like the saying goes, “Cash is king”. Well cash flow is queen. 

The Three Ways You Can Generate Cash

The Statement of Cash Flow is critical for telling you how you’re creating cash and where it is going. There are only three ways to generate cash:

Operations, 

Investing, and

Financing

Every business needs cash to stay alive. Operational cash comes from your business itself. This tells you if the business model is good and is being run properly. There are many components of Operations. They’re all important.

Investing cash comes when you sell investments that the business holds or if you sell equity. Sometimes business owners get so focused on bringing in investors (investing cash) that they forget about the business itself and lose track of whether it is profitable (operational cash). Misdirect the focus and eventually, the business inevitably fails. At some point, a business has to make money. The financing cash comes when you receive loans. I get a lot of emails about that. “Where can I get a loan to help my business?” Loans won’t help a broken model. We all have down times in our business and that’s why every business should have a cash reserve to weather those times. 

Five Rule For Operating Cash Flow That Can Keep Your Business IN Business

Follow these five rules for cash flow and you’re much more likely to stay cash flow positive. 

Operating cash flow should be positive. Cash flow can flow two different ways, to you or away from you. If you’re having to sell assets, borrow money, need to delay paying your bills or constantly infuse personal money into your business, you have a problem with your business cash flow. 

Operating cash flow should be greater than your net income. When you take a deduction for depreciation and amortization, you reduce your net income but not your cash flow. As long as you are staying cash flow neutral with your receivables, inventory and payable, you will have cash flow that is more than your net income. 

Operating cash flow should be keeping pace with net income. If net income is going up, cash flow should be going up as well. 

Operating cash flow needs to be greater than the company’s self-investing needs. A simpler way to say this is; bootstrap your business. If you have to raise money for your company to operate, you’re focusing on something different than running your business. If you have to borrow money, you now have interest payments to make. If you bring on partners, you’ll have to give up some valuable equity.

Some business models are based on growing with leverage, so the bootstrapping rule is more of one I personally use. 

If the Operating cash flow is greater than the company’s self-investing needs, then (and only then) consider one of the following:

Reinvest in the business by buying more assets, 

Repay debt, or

Distribute to owners. 

What do you plan for your business? How will you get there? And most importantly, what does your Statement of Cash Flows say about your current risks and opportunities?

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