What is your cash flow statement telling you?

Do you know the ins and outs of your business’ cash flow statement? This is invaluable knowledge that will lead your company to success

A cash flow is a business’s net amount of cash and cash-equivalents being generated or consumed by the company. The most simplified definition of a cash flow statement is that it displays a company’s ability to produce monetary value for key shareholders of the company. A cash flow statement comes in a variety of forms and purposes to grow and guide a company to the right financial state.

Different types of cash flow:

1. Positive Cash Flow

This illustrates the increase of cash that is commonly used to reinvest in the company, distribute payments to shareholders, settle existing debts or reserve for future debts.

2. Operating Cash Flow

This is cash that is generated from a company’s main business activities. It, however, does not include cash from investments or any other sources. This is purely the company’s core method of earning money (e.g. a restaurant’s operating cash flow is the number of funds gathered through every customer who bought a meal from the restaurant).

3. Investing Cash Flow

This defines a company’s capital assets or investments in other business ventures.

4. Free Cash Flow to Equity (FCFE)

This is the cash that is present after reinvestment is injected into the business. The formula to calculate FCFE is: cash from operating activities – capital expenditures + net debt issued (repaid).

5. Free Cash Flow to the Firm (FCFF)

This is a theoretical cash flow figure for a business that has paid all equity holders and debtholders after all operating expenses, capital expenditures, and investments in working capitals. This is a measure that is utilised for financial modelling and valuation.

6. Net Change in Cash

This is the amount of money that remains from the last accounting period.

How to use cash flow statements to manage your business:

1. Net Present Value (NPV)

This is an analysis of all positive and negative future cash flow of a business. Essentially, it is a form of intrinsic valuation and it is used extensively across accounting to establish the value of a business, investment security, capital project, new venture, cost reduction program, and anything related to a business’s cash flow.

2. Internal Rate of Return (IRR)

This is a discounted rate imposed on the NPV of a project zero, which means it is the predicted compound annual rate of return that will be earned by a business project or investment.

3. Business Liquidity

It is used to assess the efficiency of a business in converting its short-term non-cash assets into cash. Non-cash assets are contextual as it is defined by an industry or business type, but it commonly includes stock, equipment, and money owed by debtors.

4. Cash Flow Yield

It is used to measure how much cash a business generates per share, relative to its share price. It is presented as a ratio that compares the free cash flow per share a company is expected to earn against its market value per share.

5. Cash Flow Per Share (CFPS)

This is cash from operating activities split by the number of shares outstanding.

The benefits that cash flow statements bring to a business:

1. Cash flow statements reduce the risk of high debts

If you have taken a loan to purchase office space, service equipment and inventories, you are required to use future cash flow to make your purchases. You will need positive future cash flow to ensure you do not drown in debt. Every loan commonly requires monthly payments. Hence, it is important for businesses to obtain a good cash flow to invest in the company while clearing off debts.

2. Increase business opportunities

A healthy cash flow can help you steer clear of long-term debts and gives you the opportunity to invest in research, development, renovation, improved technology, quality employees and so on. Once you get into the stage of carrying excess cash flow, you can use that money to enhance the strategies and operations of your business. This may result in standing out against competitors, gaining new prospects, retaining existing loyal clients, building a strong brand presence and so on.

3. Cash flow statements help you make smarter financial choices

A cash flow statement is a guide to help you understand where your money goes and it will give you clarity in making major business decisions that may impact the whole structure of your business. This is essential in running a successful company in the long run.

All in all, having a positive cash flow means you are getting more money in than out for your business, and bear in mind that a high profit does not indicate a positive cash flow. Even with a high overall profit, if you fail to maintain a positive cash flow, you may face problems such as overspending. So, as much as it is important for you to focus on generating profits, you must also keep an eye on your business’s cash flow!

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