My Profit and Loss Statement shows that the business is making a profit so why don’t I have any cash in the Bank Account? Where did the money go? This is a very interesting question that does come up from time to time. Let’s explore the answer to this question. The Profit & Loss Statement shows the profitability of the business but doesn’t show all the cash transactions that could impact your bank account. For example, if you made a $ 1,500 loan payment where $ 1,000 represents the Principal Repayment and $ 500 is interest, only the $ 500 is an expense to the business and will show up in the Profit & Loss Statement. The $ 1,000 principal repayment on the loan is a transaction that effects the Balance Sheet. Therefore, the Income Statement only gives you a partial view of your business finances. In order to understand where the money went, you need to look at the Cash Flow Statement.
Before we take a close look at the Cash Flow Statement, it is important to note that these reports are generated from your accounting records. If your business accounting is not well maintained, your Financial Statements including your Cash Flow Statement will be inaccurate and will produce misleading results. Therefore, it is crucial to make sure you have good accounting records that are updated on a daily basis. Read this article if you are interested to learn more about the benefits of implementing a real-time approach to your bookkeeping and accounting records. In our article: Bookkeeping Services for Small Business we explore some major benefits of outsourcing your business bookkeeping.
Overview of the Cash Flow Statement:
The Cash Flow Statement summarizes the amount of cash entering and leaving the business. This report is intended at helping you answer one single major question: where did the money go?
The Component of the Cash Flow Statement:
The Cash Flow Statement is broken down in three major areas:
- Cash from Operating Activities: This is cash entering and leaving the business from the normal day to day business operation. This is a good starting point because it provides information regarding the amount of money a company brings in from its ongoing, regular business activities. Negative Operating Cash flow can result from having too much in outstanding invoices that have yet to be paid by your clients or customers. Negative Operating Cash flow can also indicate higher costs that are impacting your bottom line. Therefore, this section should be closely monitored over time.
- Cash from investing activities: This is cash that is entering and leaving the business as a result of investments like purchasing equipment or inventory. If you purchase a new office desk, this is an investment activity and the cash used for the purchase of that desk will show up in this section of the Cash Flow Statement. It is not uncommon to see new businesses investing significant amount of cash on new equipment, perhaps there is a push to modernize the office or the business needs a new vehicle. Therefore, this section of the Cash Flow Statement should be reviewed on a regular basis in order to understand what investments the business is making.
- Cash from financing activities: This is cash that is entering and leaving the business as a result of things like repayment of business loans, or business owners taking cash out of the business in the form of distributions.
With the help of your trusted Accountant you should review your Cash Flow Statement on a monthly basis. Your accountant is uniquely trained to add necessary context around the information presented in your Cash Flow Statement. This is one of the reasons you should consider working with an Accountant on an ongoing basis, you can read this article to learn more about the benefits of working with an Accountant. Business owners often consider negative cash flow as a negative sign, your accountant can help you better understand the information presented in the report and why a negative Cash Flow might not always indicate a negative event.
The Bottom Line
A cash flow statement is a critical financial report that you should consider reviewing on a regular basis in order to answer the question: Where did the money go? Once this question has been answered, you can use this information to then evaluate ways you can improve your business cash flow in order to reach your overall business objectives.