In order for a business to survive, the business must be able to generate and sustain a positive cash flow. Understanding the basic concepts of cash flows will result in good cash management. In preparing the financial statements for a business, a balance sheet, income statement and statement of cash flow are usually presented. The balance sheet shows the Company’s assets, liabilities, and retained earnings at a point in time and the income statement shows the income, expense, and net income or loss. The statement of cash flows provides information about the cash receipts and disbursements of the Company during a given period as well as the investing and financing activities.
The cash flow statement is normally used to assess the following:
- The Company’s ability to generate future cash flows that is positive.
- The Company’s ability to meet its obligation, i.e. pays its debts.
- The cash and non-cash elements of the Company’s investing and financing activities.
The cash flow statement is comprised of three categories, 1) Operating, 2) Investing, and 3) Financing.
1) The operating category represents sources and uses of funds from the operation of the Company. The funds relate primarily to revenue and expense items presented in the income statement. Some examples of operating cash inflows are receipts from sales, interest income, and rental income. Examples of operating cash outflows are salary expense, administrative expense, and rent expense. Non-cash operating items includes gain or loss on disposal of assets and depreciation expense.
2) The investing category represents assets and investments of the Company. Examples of investing cash inflows are proceeds from the sale of investments, collection on loans made to others and sales of assets. Examples of investing cash outflows includes purchase of fixed assets, Loans made to others, and capitalized interest.
3) The financing category deals with financing of the Company. Examples of financing cash inflows are proceeds from loans, capital contributions, and advances made to the company by a related party. Examples of financing cash outflows includes distributions, principal payment on debts, and repayment of advances.
In laymen terms, if you take in more cash than you spend, then you will have a ‘Positive’ cash flows, which is what you want in order to meet the Company’s debt and grow the Company. In contrast, if you spend more cash than you take in, then you will have a ‘Negative’ cash flow and will have difficulty in meeting your debts. A positive cash flow allows the Company flexibility in making purchases and investments, and more importantly, make the Company more desirable for banks to do business with. Start your business by practicing good cash management, this includes knowing your cash needs, identifying the best source of financing, and always being prepared to meet the Company’s cash flow needs when they occur.
We hope this blog provided useful and valuable insight on practicing good cash management. For more information and insight contact us at (301) 797-8259