Use Your Financial Statements to Improve Your Business: Cashflow Statement

Understanding the movement of cash within your business is a must as anyone who has faced insolvency can tell you! Cashflow is the pulse of your business, so it’s no wonder your cashflow statement serves as a medical exam of common ailments that plague SMBs.

This blog is the third in this series, with the previous two looking at the income statement and the balance sheet. This blog unpacks some of the key indicators a financial consultant or investor will look for in your statement of cashflow that will allow you to better plan ahead, grow and protect your business.


Why Do We Bother With Cashflow Statements?

I hear you say “Incomings and outgoings are essentially the same as profit and loss in a SMB – right? What are the actual benefits of time spent monitoring cash accounts?”

First off, it’s important to understand that the cashflow statement is just part of the depiction of your company’s position contained within your financial statements. It matters because it contains specific insights that other statements do not. Determining how to identify a healthy cashflow isn’t just about staying solvent and meeting your obligations, but identifying a healthy balance of stability, growth and liquidity for contingencies. Actual percentages will look very different from one industry to another, but the principles remain the same. Cashflow management is about planning as well as monitoring.

The profit loss statement shows the overall revenue and profit. However, these figures are often reflective of sales and not necessarily payments. Depending on the method of payment and management of accounts receivable, a sale isn’t actually visible on the cashflow statement until the payment is received which can significantly lag the sale date (provided you ever actually get paid by the client). Working capital is essentially the margin between your accounts receivable (to be clear – money that has actually cleared in your account that you can spend) and your accounts payable. Thus your profit loss statement is useful for understanding company sales whereas your cashflow statement reflects your actual capacity to pay debts owed and invest.

Definition: Capex:
Capital expenditure often referred to as capex, is another primary health indicator for your company. As discussed above, it is the margin of cash available to cover costs (maintenance capex) and reinvest (expansionary capex).


Credit Control

One indicator to observe on your cashflow statement is how well your current business processes can recover outstanding invoices. How close to the line does your business run each month? How much is left over each month once you’ve paid your bills? This is very analogous to your personal finances, with the exception of the severity of legal consequences for insolvent trading for businesses. Ideally, as a business owner you want to pay yourself and have enough cash left over to grow your business. If your cashflow statement is showing you are barely doing this, even when your profit loss statement looks good, it’s a good sign your payment recovery systems may need improvement such as narrower due dates on invoices, more controls on extending lines of credit to clients and stronger follow-up systems for overdue accounts.

You can monitor this with a metric that compares overdue accounts payable to sales. It’s a simple formula defined as overdue accounts divided by total sales multiplied by 100 to give a percentage value.

This becomes easier if you ensure due dates fall within the month by sending out billing at the start of the month.  This way by the time the month is up, all due dates have passed and it’s easy to calculate. Alternately your accounting software will be able to perform this analysis if your accounts receivable due dates are dispersed throughout the month. Be sure to chat with your bookkeeper or account if you need help setting this up.


Inventory Management

Many SMBs have much of their working capital tied up in inventory, especially if you are in retail or manufacturing. The past year has presented numerous disruptions to supply and demand levels, so this is a big area to watch for many businesses right now. As lockdowns have affected supply lines and either drastically increased or decreased demand on goods, it’s challenging to know how much to restock.

On the one hand if your supply network is slow or at risk of getting cut off in a quarantine scenario, you may consider purchasing additional stock now while you can get it. On the other hand, this may eat up your working capital and leave you exposed in consecutive months by low sales or even a lockdown scenario. Scenario planning for the worst-case scenario will give you greater confidence in how you manage your capex by taking some of the mystery out of what investment and reserve cash margins would protect your company in a downturn.


How To Interpret All Of This?

A business that is early in its life-cycle is likely to growing fast and will require capex to grow. In this scenario, you’re likely to see low or even negative cash flow, as it’s being reinvested into the business for purchases of assets, wages and inventory etc. This is likely a good thing. The signs of health an investor may look for is growth in the net volume of cash in and cash out indicate if the business is expanding its customer base and/or turnover. However this negative cashflow can only be sustained for so long, and sooner or later the invested capex must begin to return a positive cashflow in future quarters.

A more mature business will likely have an established customer base and steady cashflow rates should be expected (accounting for seasonal/market changes if necessary). If a company is selling off assets to top-up cashflow holes – that is a sure sign the company is contracting and it is a good time to re-evaluate the business plan. If there is cash accumulating month-on-month, perhaps there are opportunities to reinvest or upgrade assets.


Key Metrics to Keep an Eye On:

Net Operating Cash/Sales

The net operating cashflow figure that appears in your cashflow statement is where you start. It can be useful to (divide) this by the net sales to better understand how much cash is generated for every dollar in sales. There is no ideal general figure, but the higher this ratio the better.

Inflow/Expenditure Ratio

This metric used for understanding how close a company is to running out of cash before the end of the month. Each industry is different, so benchmarking is prudent when evaluating what ratio is suitable for your business. In general, the lower this ratio sits to 1:1, the more exposed a company is to a downturn in the market.

Free cashflow

Often defined as the net operating cash minus capital expenditure, the free cashflow metric is essentially cash that a company is free to do whatever it wants with. This figure can be of interest to investors as free cashflow is often used to pay dividends. As an owner of an SMB, you might not have any other shareholders other than yourself (yes – wouldn’t a cash surplus be nice for once).

TIP: Make sure you look back in time further to see the trend over time in case you see seasonal trends or recognise the same trends in comparative markets. Such trends are useful to factor into your cashflow planning.

Cashflow trouble comes in many forms. Increasing the sales of your product or service is not the only key to ensuring your business thrives. As we’ve discussed, perhaps there is wiggle room in your inventory management to create budget for paying down debt or expansion. Or perhaps you’re tired of taking a personal hit to your wage by unpaid accounts receivable (or you’ve got supplies on your back with overdue notices). Our experts are here to help you not only climb out of the hole, but set in place better systems to ensure you don’t end up in the same cashflow woes again. We’re here to help – let’s chat.

Contact our business specialists to book a free first-time consultation;

Dean Vane:

Lauren Steinheuer:

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