Can You Define Cash Flow for Your Business?

Knowing what makes up cash flow is the first step to avoiding a cash crisis. The majority of business owners believe it is the revenue they generate less the expenses they pay.

The answer lies in the fact that the accounting rules that govern the creation of a financial statement are not tracking the flow of cash through your business. The statements are focused on measuring profit or loss.

The P & L (Profit and Loss) is the net income. Net income does not tell you what happened to your cash balance through the period in question. It defines net income based on the accounting rules that were used to create the income statement.

Many items never show up in an income statement while other cash flow items will show up there but in different periods and in different amounts. You will find that an income statement will not show what happened to cash flow.

It is made up of more than just profit and loss. Things affected are:

-Accounts receivable

-Inventory

-Accounts Payable

-Capital Expenditures

-Borrowings and debt service

Therefore, a business cannot look at an income statement and see what happened to the cash during the month. Profit and Loss is only one component of cash flow. A business has to have a clear picture of how each of the other areas affect it each month in order to understand and take control it.

An example:

-Recently, a client could not understand why his income statement said he made money last year but he didn't have enough cash to pay all of his bills. In this case, the difference between his net income and his cash flow was a result of the purchase of a truck for cash, sales made during the period that were not collected (accounts receivable), an estimated tax payment made an amount different than tax expense for the period, a distribution to the owner, and payments on a bank loan.

As you can see the rules of accounting determines when transactions are recorded in the financials and how they are recorded.

The reality of business determines when cash is received or when cash is dispensed.

In addition to having a P & L that governs accounting life, it is important to keep a schedule that governs monthly cash flow. The secret to taking control of cash flow is to have an easy to understand view of each component of the business that affects it. The cash flow schedule needs to show what is going on with each of the components as mentioned above.