Using the Statement of Cash Flows to Make Better Decisions

What’s the first priority for your business during the coronavirus pandemic? For many businesses, the biggest concern is cash flow. In April of 2020, a WalletHub survey reflected that 87% of small business owners were struggling due to the virus, and cash flow was a big factor.

You need tools to make informed cash management decisions, and the statement of cash flows is a good place to start. Once you understand the cash flow statement, you can plan for different scenarios and decide on a path forward. Let’s start with the definition.

Understanding the Cash Flow Statement

The statement of cash flows reports cash inflows and outflows for a period of time (month or year). The statement assigns cash activity to one of three categories:

• Cash flow from operations: Operations refers to the day-to-day activities in your business. When you order inventory, process payroll, and collect payments from customers, the cash flows relate to operations.

• Cash flow from investing: This category includes buying and selling assets. Every business needs assets to generate revenue, and if you purchase equipment for cash, the cash outflow is posted to the investing category.

• Cash flow from financing: When you raise capital or pay it back, the cash transactions are financing activities. Issuing stock is a cash inflow, and paying a dividend is a cash outflow.

Here is the Formula to Generate the Statement of Cash Inflows:

Beginning cash balance + net change in cash for all three categories = ending cash balance.

The ending cash balance for the period should equal the cash balance in the balance sheet for the same date. If you’re generating the cash flow statement for September, the ending cash balance should equal the 9/30 cash balance in the balance sheet.

Why Operating Cash Flows are Important

The vast majority of your firm’s revenue and cash inflows must be from operating activities. Your day-to-day business is sustainable and repeatable, but that isn’t true of non-operating revenue.

Say, for example, that you manufacture furniture, and you decide to sell a piece of machinery. The gain on the sale generates income and cash inflows, but selling an asset is an investment activity. You’re not in the business of selling machinery, and you don’t expect to sell other assets each month and year.

The same is true of financing activities. If you issue stock or take on debt, more cash comes in the door- but these transactions don’t generate revenue. You’re raising capital, and both shareholders and creditors expect repayment.

To increase the value of your business, focus on revenue and cash inflows from operations.

Where do you Stand Now?

The next step is to assess your financial position right now. Run a full set of financial statements, including the balance sheet, income statement, and statement of cash flows for 2020. This is a stressful but necessary step to make informed business decisions.

The current status of your business - months into the pandemic - depends heavily on your industry. As Deloitte pointed out earlier this year: “Businesses in sectors such as tourism, hospitality, entertainment and air transportation have been particularly hard-hit in the short term.”

Once you understand your current position, you need to ask yourself some tough questions.

Finding a Path Forward

The answers to these questions will help you find a path forward:

Do you Need to Pivot?

Do you have a sustainable business model, or do you need to pivot? Steve Blank, an authority on business pivots, defines a pivot as a major change in your business model.

It’s likely that you’ve already made some changes to respond to the pandemic, including beefing up your ability to serve clients online. Assume, for example, that you own five sporting good stores. Local regulations allow a limited number of customers to visit your store, and you’ve shifted most of your business online.

Your revenue and cash flows initially declined 70% per month, and have recovered to a 40% monthly decline from prior year. You’re generating 60% of the revenue you expected each month, and nearly all of the business is online.

When will customers be comfortable visiting your store again? That’s hard to say, given the uncertainty about a vaccine and other factors.

How Will You Do Business After a Pivot?

If you decide that the majority of your sales will be online for the next year, how does that change your revenue and expenses?

• Physical space: If your lease agreement ends within the next year, should you lease the same amount of retail space?

• Payroll: Can you manage the online business with fewer employees and do you have the right team to work remotely?

• Marketing: Do you need to spend more dollars to make customers and prospects aware of your online business?

• Technology: Does your business require a bigger investment in technology to serve customers online?

These income statement decisions also impact your cash position.

Can You Generate Enough Cash Inflows After a Pivot?

Many business owners hear the term “cash flow positive” and assume it means the same thing as profitability. However, although the two terms are related, they’re not actually the same thing. As it turns out, you can be profitable without being cash flow positive—and you can be cash flow positive without being profitable!

Imagine that over the course of a few months, your company has a sales volume of $75,000.

You do your budget and estimate your expenses to be about $50,000. That leaves you with $25,000—in profit, right?

But a few of our clients do not pay you on-time or you are waiting on credit card payments to process, so your cash flow at the end of the month is short $25,000, now what?

That age-old saying “Cash is King” becomes very important in a downturn economy. Cash flow is the single most important financial factor. If you want to learn more about cash flow watch this YouTube video, The Power Of Your Financials, Cash Flow 101.

Susan Frew, Raincatcher’s preferred exit advisor, shares there are five critical areas every small business owner MUST address in order to attract new clients, generate more revenue, and increase profitability; leads, conversions, number of transactions, average sale value and profit margins. Her program helps teach business owners a business-changing formula that will help to double profits.

There are tough questions, but you don’t have to resolve these problems on your own.

Find an Expert

When you’re making tough decisions, find a trusted expert who has been there before. The professional business brokers at Raincatcher have advised hundreds of businesses, and helped owners increase profitability. They can explore ways to increase cash collections, reduce expenses, and to find a path forward during the pandemic.

If you’re interested in preparing your business for sale, the staff at Raincatcher can work with you to close a sale at an attractive price. Find a trusted advisor, so you can make the decisions that will improve your business.