Success in business requires certain measures that includes following stringent tried and tested business laws.
One of these laws is the law of “cashflows”.
Remember ships don’t sink because of the water around them, but they sink when water gets into them.
Although economy cannot affect a well-positioned business.
In some of my works, I have explored why financiers reject an entrepreneur’s application for financing.
Cashflow statements play a very important role for financiers to determine whether the enterprise is viable.
Loan applications are often thrown out due to unsatisfactory cashflows.
Cashflow statements are financial documents designed to give an insight into the financial health and status of an entity.
- Putting your vision into a money-making venture
- Interpreting cashflow statements
- National Foods pays dividend to employees
They give a picture of what transpired or is likely to transpire to a business’s cash during a specified period.
It demonstrates an organisation’s ability to operate in the short and long term, based on how much cash is flowing in and out of the business.
The statement of cashflows is one of the three key financial statements that report the cash generated and spent during a specific period of time.
It acts as a bridge between the income statement and balance sheet by showing how money moved in and out of the business.
It measures how well a company manages its cash position, meaning how well the company generates cash to pay its debt obligations and fund its operating expenses.
The cashflow statement complements the balance sheet and the income statement.
Through it, a picture is painted in the mind of financiers and investors of how a company’s operations are running, source of its money and how it spends the money.
It tells investors whether a company is on solid financial ground or not.
These are cash activities that show the generated cash from its trade or services. It includes both expenses and sales. It includes the receipts from sales of goods and services, sale of equity, interest payments, tax payments, suppliers’ payments, rentals, salaries and wages and any other operating expenses.
These are transactions that include cash realised from the selling and the buying of assets both physical eg real estate or cars and non-physical property assets like patents, shares etc using cash and not borrowings.
Investing activities include any sources and uses of cash from a company’s investments. Loans made to vendors or received from customers, or any payments related to mergers and acquisitions are included in this category.
This is the section that details both equity financing and debt. These activities include the money received from banks, investors loans, as well as dividends paid out, cash paid for stock or share repurchase and debt repayments that are made by the company.
Changes in cash from financing are cash-inflows when capital is raised and cash-outflows when dividends are paid.
Ideally, a company’s cash from operating income should routinely exceed its net income, because a positive cashflow speaks to a company’s ability to remain solvent and grow its operations.
It reveals whether a company is making money or not.
It is important to note that cashflow is different from profit, this is the reason why a cashflow statement is often interpreted together with other financial documents, such as a balance sheet and income statement.
It reveals money usage versus income whether there is a misuse or an imbalance.
The statement highlights how well it generates cash.
Cashflow statements can reveal what phase a business is in: whether it’s a rapidly growing start up or a mature and profitable company.
It can also reveal whether a company is going through transition or in a state of decline.
Departmental heads may use cashflow statements to understand how their particular department is contributing to the health and wellbeing of the company and use that insight to adjust their department’s activities.
Cashflow statements also impact internal decisions, such as budgeting, or the decision to hire (or fire) employees.
They help creditors determine how much cash is available referred to as liquidity for the company to fund its operating expenses and pay its debts.
For a business to be successful, it should always have sufficient cash. This enables it to pay back bank loans, buy commodities, or invest to get profitable returns. A business is declared bankrupt if it doesn’t have enough cash to pay its debts. Here are some of the benefits of a cashflow statement:
Gives details about spending: A cashflow statement gives a clear understanding of the principal payments that the company makes to its creditors. It also shows transactions which are recorded in cash and not reflected in the other financial statements. These include purchases of items for inventory, extending credit to customers and buying capital equipment.
Helps maintain optimum cash balance: A cashflow statement helps in maintaining the optimum level of cash on hand. It is important for the company to determine if too much of its cash is lying idle, or if there’s a shortage or excess of funds. If there is excess cash lying idle, then the business can use it to invest in shares or buy inventory. If there is a shortage of funds, the company can look for sources from where it can borrow funds to keep the business going.
Helps you focus on generating cash: Profit plays a key role in the growth of a company by generating cash. But there are several other ways to generate cash. For instance, when a company finds a way to pay less for equipment, it is actually generating cash. Everytime it collects receivables from its customers quicker than usual, it is gaining cash.
Useful for short-term planning: A cashflow statement is an important tool for controlling cashflow. A successful business must always have sufficient liquid cash to fulfill short-term obligations like upcoming payments. A financial manager can analyse incoming and outgoing cash from past transactions to make crucial decisions. Some situations where decisions have to be made based on the cashflow include foreseeing cash deficit to pay off debts or establishing a base to request credit from banks.
Cashflow statements can be depicted as being positive or negative. When they are positive it means that the business is taking in more cash than it’s expending. Whereas when it is negative the business is said to be spending more cash than it’s receiving due to various reasons.
This is an ideal situation to be in because having an excess of cash allows the company to reinvest in itself and its shareholders, settle debt payments and find new ways to grow the business.
Positive cashflow does not necessarily translate to profit, however. Your business can be profitable without being cashflow-positive, and you can have positive cashflow without actually making a profit.
Higher cash outflows than cash inflows during a specified period translates to negative cashflows.
But it doesn’t necessarily mean profit is lost.
Instead, negative cashflow may be caused by expenditure and income mismatch, which should be addressed as soon as possible.
Negative cashflow may also be caused by a company’s decision to expand the business and reinvestment for future growth, so it’s important to analyse changes in cashflow from one period to another, which can indicate how a company is performing overall.
Entrepreneurs need to record their day-to-day transactions correctly no matter how small the business is. Correct recordings elevate a business when the time for loans and call for investments beckons. It doesn’t matter how big or small a business is.
Banks will still require good cashflows to be prepared. For big organisations their accountants may prepare the cashflows. For small organisations it is important to seek advice from professionals like this writer.
- Chitambira is the founder of Smartfiscal Consultants — a business advisory firm. He can be reached on [email protected],