Earlier this week I was having coffee with a potential client when I heard two interesting statements from him within 5 minutes. It started with him saying, “My income statement doesn’t make sense to me. It says I have this huge net income, but that cash isn’t in my bank account”. A few minutes later he next commented, “I am really interested in having you look at my income statement, I am not too worried about the others like that cash flows statement”.
For the record, he was talking about the Statement of Cash Flows. It’s not the first time I had heard this sentiment when it comes to this statement. While the statement is a favorite of CPAs and finance people, most others could do without it. I have sat in many meetings reviewing financial statements and when we get to the cash flow statement, owners usually tune out.
A lot of this general disdain for the statement of cash flows is squarely on the shoulders of us CPAs. Often business owners will ask their CPA why they don’t have more cash and my profession just muddies the water even more. Ask a CPA a question about the Statement of Cash Flows and what you often get is an answer that sounds like they are speaking a foreign language. Because of this, most of you have developed a strong aversion to the Statement of Cash Flows.
This situation is unfortunate because I think this statement is often the most useful financial statement to business owners and investors. Once owners have identified the triggers to increase cash flow they are often able to make strategic decisions that create a stronger business.
For a business owner to increase their understanding of the Statement of Cash Flows, we CPAs need to simplify things a little. Simplification has somewhat become a long lost theory in the CPA and financial professionals world. Business owners merely want an answer to the question “What happened to cash last month?” They want the answer in 2 minutes, not 2 hours or even 20 minutes.
Why do we Even Need A Statement of Cash Flows?
The income statement does a good job of showing the company’s revenue and expenses. For most small businesses, it is straight forward. However, all businesses spend cash on things that aren’t expenses. For instance, a business might buy equipment or pay down a loan. Those transactions are not accounted for in the income statement. Further, while revenue and expenses are recorded, they might not be received of paid until later.
At the top of the cash flow statement starts is your income or loss from your income statement and then it shows the adjustments to reconcile what amount of cash you started with and how much you ended with.
Most growing small businesses are spending cash on things like inventory. However, this is only recognized as an expense when it is sold. They also might be financing their revenue by offering credit terms to their customers. This creates receivables due from their customers. While this gets included in revenue when sold, the cash might not necessarily be collected at that time.
One last example is a loan. When a company pays a loan, the balance is decreased on the balance sheet rather then the payment is accounted for on the income statement.
Because items like these, the Statement of Cash Flow is needed. It reconciles the difference between net income or loss and the change in cash. What my profession has done a bad job doing is explaining these differences to our clients. The understanding of this statement is powerful. If an owner understands that the reason their income statement looks so great but their cash-poor is that they have a collections problem or too much inventory, they can start to make changes to generate cash. Where a CPA, CFO, or financial professional can really add value to business owners is by identifying these items and bringing them to their attention. By explaining it as I have above, business owners can then adjust their strategies to make a good business better.
Krieger Analytics works with businesses to help them with their profits and grow through accounting, finance, and bookkeeping. We are not the perfect match for all businesses so we have honest conversations upfront to see if we are a good match for you. Contact us now for a call to learn more about us and have a conversation about your business.