The Cash-Flow Statement

Customer satisfaction, employee satisfaction and cash flow the three most important

indicators for business.

The third component of financial statements is the cash-flow statement. There are two types of

cash-flow statements—one examines cash flows for a given period (historic), and the other is a

projection of future cash flows. Thehistoric cash-flow statement is similar to the income

statement in that it looks at cash inflows and cash outflows for a business during a specified

period of time. Like the income statement, these periods of time can be the fiscal year, the fiscal

quarter, or a month. The cash-flow projections statement attempts to identify cash flows into a

firm and cash flows from a firm for some future period. This projection is extremely important

because it may identify future subperiods in which a firm is producing a negative cash flow—

where cash outflows exceed cash inflows.

From the standpoint of a small business owner, cash-flow statements provide insight into where

cash flows are coming and going. The cash-flow projections statement may be the most

important component of all the financial statements. Its importance stems from the fact that the

flow of cash into a firm may not be synchronized with its cash outflows. Should there be a

significant mismatch with cash outflows being significantly higher than cash inflows, a business

may be in great difficulty with respect to meeting its current obligations, such as payroll, paying

suppliers, and meeting short-term creditors. As we will see, cash-flow projection statements

require several forecasts. These are discussed later in this section.

At some point, many businesses will experience negative cash flow. In fact, a negative cash flow

is quite common in start-up operations and high-growth businesses where there is a pressing

need for capital expenditures, research and development expenditures, and other significant

cash outflows. One can also see the recurring presence of negative cash flows in businesses with

seasonal sales. Negative cash flows can be covered by short-term borrowing. However, this type

of borrowing brings up two important issues. First, any type of borrowing raises the overall debt

level of a business, which might have an impact on the interest rate on the debt. Second, when a

negative cash flow exists either because of an unforeseen exigency or because a business owner

has failed to properly conduct a cash-flow projection analysis, a lender might look at a business

in a jaundiced manner, which could have long-term consequences for a business.

A careful examination of the cash-flow statement could illustrate a point that has been

mentioned several times in this book: there can be a significant difference between positive cash

flow and profit. In looking at the income statement, one could find a positive net income (profit)

and then examine the cash-flow statement and discover that a business has a significant

negative cash flow. The cash-flow statement specifically maps out where cash is flowing into a

firm and where it flows out. A properly developed cash-flow statement will show if a business

will be generating enough cash to continue operations, whether it has sufficient cash for new

investments, and whether it can pay its obligations.