“I have made lots of profits, but where is the money?”, laments a hard-working entrepreneur. Or “My profit and loss account say I made x profits, but my closing balance of bank statement is 0.5x. Where is the money gone?” Sounds similar? The answer to your question is in your cash flow statement.
Unfortunately, most entrepreneurs turn a blind eye to their own financial statements. They believe the financial statements are only for the accountants, filing taxes and compliances purposes. However, the same financial statements can be utilised to analyse and better the future.
A cash flow is most neglected among financial statements, with it not being mandatory for most organizations, they even avoid preparing it. A cash flow helps in understanding and managing cash flow better.
A cash flow begins with adding back depreciation and interest and any other expense for which actual outflow of funds has not happened to the reported profit after tax.
From the above the amounts blocked or released in working capital are added or reduced. These includes changes in debtors, creditors and inventory and other balances like short term assets or liabilities. So, if inventory, debtors, current assets increase it amounts to further blockage of capital and is hence reduced and vice versa. For creditors and current liabilities an increase in these balances mean we did not pay them and hence its an improvement to our cash flows and hence this is added and if these balances declined it is reduced. The net cash from operating activities is important to monitor. This must be a healthy positive. It is here that most business falter. You may generate profits, but you may block these profits into your working capital. Hence the above-mentioned balances need to be watched well. Also, one should respect the credit periods of both receiving and payments.
One must also keep in mind that the priority of any business should be to ensure working capital cash flows are adhered to first. Once this milestone is reached, we can look at the financing needs of the business which is any interest or principle repayment of loans borrowed or dividend to be paid to equity investors.
At the last stage should be the cash flow needed for investing activities, that is into new assets or expansion. This stage should come third. Also, one blunder most businesses commit is to use short term funds for long term requirements. This starves the businesses from oxygen to survive. It is important to ensure that money should be utilised for long term purposes only when operational and financing cash flows are met. Or we need to raise long term funds for long term investing needs. Short term funds from business or from loans taken for short term needs should not be blocked-in long-term needs. This is so as returns from long term investments come over a longer time and hence the required cash flow that is needed for short term purposes could be blocked for a long term and hence choking the business.
Every business should be respectful of its cash flow statement. Each cash flow statement tells us a story provided we are willing to listen.
