You need cash to run your business. Then why don’t you know how to read your cash flow statement? It might be the truest way to tell when the tank begins to run seriously dry.
I don’t mean your profit and loss (P&L) statement and I don’t mean your balance sheet. I bet that lots of you run businesses that don’t even prepare a cash flow statement.
This statement combines your P&L and balance sheet to tell you what happened to your cash over a given period. It tells you if you create cash or use cash. And if you don’t create cash, you and your company might come in for an unhappy surprise.
Thought your P&L told you if you made money? Your P&L can tell you revenues, costs and expenses and whether you made money according to generally accepted accounting principles – guidelines that sometimes don’t help a lot with the realities of running a small business.
For instance, remember that bank loan you made a payment on? The principle of that loan doesn’t show up on your P&L; it does show up on your cash flow statement. Ditto the cost of that new truck you just bought for the business and the money you spent on increasing your inventory.
In your business, you either create cash or use it. If your business grows really quickly you might actually show a profit while having negative cash. Think of firms worth a lot on paper because they have big deals in the works – deals still yet to pay a dime.
Your cash flow statement tells it like is. These documents are one of the quarterly financial reports any publicly traded company must disclose to the U.S. Securities and Exchange Commission and – maybe an even harsher judge – the shareholding public. In your hands, this document is your best business friend who always puts the truth to you straight.
If you look at your cash flow statement at least monthly, you can see trends. You see if your inventory grows. You see if your principle payments to lenders are too high and you might see need to re-negotiate a better repayment schedule.
Once you understand your cash flow statement, you really start to get a handle on what’s going on in your business. And so do others.
Banks, for example, are very aware that cash reigns in your business. Your bank will take your numbers and look first for how many times your cash flow can make interest payments on your outstanding loans. If your cash flow is $200,000 and your interest payments $20,000, your bank will be happy.
Next your bank sees how your cash flow does paying both interest and principle. With the above numbers, if your annual bank payments total $50,000, your bank is still happy. If your annual payments total $150,000, on the other hand, your bank might not be as happy.
In short, to know how your bank thinks, know how to read and understand your cash flow statement.
Happiness (in business, anyway) is positive cash flow. Know how to spot it.
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Josh Patrick is a founding principal of Stage 2 Planning Partners in South Burlington, Vt. He contributes to the NY Times You’re the Boss blog and works with owners of privately held businesses helping them create business and personal value. You can learn more about his Objective Review process at his website.
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