Have you ever felt like your business is booming but you still struggle with paying the bills? Or maybe you don’t feel like you are making any money but always end up with large tax bill? The solution to your dilemma might be in the statement of cash flows (SCF).
Statements of cash flows show the inflow and outflow of cash for a specific period of time. There are two methods used to prepare a SCF: direct method and indirect method.
- Direct method lists the major categories of cash receipts and disbursements (e.g., customer receipts, supplier payments, interest, income taxes, investing activities, and financing activities).
- Indirect method is prepared by adjusting net income for non-cash transactions recorded on the income statement and then for cash transactions for investing and financing activities (e.g., purchase of fixed assets or proceeds from the issuance of debt).
In most cases, an SCF prepared using the direct method gives a more complete picture of company’s (and its owner’s) cash situation than a SCF prepared using the indirect method. However, most SCF’s are prepared using the indirect method due to the direct method being a cumbersome process.
Meeting with your CPA to review your SCF can help business owners evaluate the company’s liquidity and assist in identifying opportunities to improve the company’s available cash. Most accounting software in the market has the ability to generate a SCF, as well.
Regularly reviewing an SCF is also a useful planning tool. An SCF highlights the areas that can be improved or need extra attention. For example, if an SCF shows an increase in the accounts receivable balance and a decrease in net income, the business may need to take a look at the company’s credit policy and collection process. More specifically, whether credit terms offered to customers are appropriate for the customer’s financial situation; whether an accounts receivable aging is reviewed on a regular basis; whether customers with old receivables are being contacted on a regularly; or whether customer’s credit accounts are frozen after they become delinquent. Understanding an SCF can help owners and managers gain insight in knowing where to be more aggressive in expanding its operation or, conversely, when to look for operational efficiencies to keep the business running smoothly.
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