What a cash flow statement can reveal about your business

If you want your small business to become more profitable without changing your product portfolio, one way is to start paying close attention to its cash flow statement.

An income statement shows the net profit of a business, while cash flow shows how much cash you have on hand. Net profit is not the same as cash in hand, because the income statement and the balance sheet are based on an accrual method. They reflect transactions that have taken place, but they do not indicate whether actual cash has gone out or come into the business.

In theory, a business that looks very profitable may be very short of cash, and unable to meet basic liabilities like payroll.

This is where the cash flow statement becomes important. It is based on actual cash outflow and inflow. Thus, the cash flow statement provides a detailed map of where the business’ income comes from, when it arrives in the bank, and when and where it goes. That makes it very useful for day-to-day operations.

The cash flow statement has three main components:

1. Cash from operations
2. Cash from investing
3. Cash from financing

Reviewing your cash flow statement can give you essential insights into the health of your business. Here are a few things your cash flow statement may reveal:

You’re carrying too much inventory

Excess inventory costs money to store. Improve your cash flow by ordering raw materials only when they are needed in the production process, to maintain appropriate inventory levels.

Your customers are taking too long to pay

You can shorten the payment cycle by communicating payment terms clearly, following up on invoices soon after you send them (not after they become overdue), invoicing right after a job is finished, and quickly solving any discrepancies

Even though business owners are sometimes reluctant to negotiate with customers due to fear of losing them, RIABU helps small businesses improve their receivables by focusing on using innovative service tools to minimise the Days Sales Outstanding (DSO).

You’re paying your bills too fast

Conserve cash by negotiating with your suppliers for more favourable payment terms.

Your business operations are generating enough cash in the long term

Cash flow comes primarily from operating activities. Your business may appear to have a healthy net income but if it is not generating enough cash, your business isn’t sustainable. A business can only generate consistent cash flow if it focuses on service, trust-building and customer loyalty. We call this the Virtuous Revenue Cycle, which is one of the core concepts in our book Let The Cash Flow.

You can attract lenders or investors

Many investors prefer businesses that consistently generate a lot of cash. Banks also look closely at the financing section of your cash flow statement to see how you have handled loan repayments in the past.

You have excess cash that you can put to good use

Sometimes, a business has excess cash on hand that could be used more profitably by purchasing equipment or other assets, or just by moving it into an interest-bearing account.

In short, your cash flow statement is a window into the health of your business. So use it wisely!