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How to Create a Cash Flow Statement and Keep Your Business Finances in Check

Finance
Article
01/04/2019

A business's cash flow ebbs and flows like the ocean tide. Stating what is perhaps obvious, when money comes into the business, cash flow increases; when bills are paid and money goes out, cash flow decreases. Sounds simple enough, but poor cash flow management may undermine business success.

Here are some steps to help you create a cash flow statement and keep a better handle on income, whether you run a restaurant, a retail shop, or even an online-only business.

1. Distinguish between sales and cash flow

Bringing in sales does not necessarily indicate that a business has the funds on hand to pay bills when they're due. Sales do not always equate to cash in the bank; it is necessary to collect payment on those sales in order to turn them into cash.

Understanding cash flow is vital to:

  • Staying in business — If a business becomes delinquent in paying its bills, creditors can force it out of business. Not paying certain bills, such as employment taxes, can result in 100 percent personal liability for owners, even if the business goes under.
  • Enjoying good business credit — Failing to pay bills in a timely fashion can hurt a business's credit rating. This can result in being unable to obtain loans or, if able to get a loan, having to pay higher interest costs for borrowing. It can also potentially mean losing business because companies can check others' credit ratings when making business decisions.

2. Learn to build an effective cash flow statement

A cash flow statement shows the change in the business's cash balance during a specific period of time. Not only does this statement show the change in the cash balance, but it will indicate how the business's cash balance changed. It will signal if the business made or lost money from normal operations, if the business borrowed money, if it lent money, how much debt it paid back, and more.

A cash flow statement starts with a business's beginning cash balance. This is a summation of bank balances plus any petty cash on hand. The next step is to analyze cash inflow over a certain period — typically a month, quarter, or year — by listing all cash receipts. Sources of cash during that period can include sales, but only if the business actually received cash for the purchase. Sales on credit won't be considered on a cash flow statement until the period in which the customer pays the balance due (or a portion of the balance due). Interest earned on financial accounts during the period is also added to the cash inflows.

Once total inflows of cash have been measured, the next step in learning how to create a cash flow statement involves determining how much the business spent to maintain or grow the business. Examples of cash payouts range from payments to suppliers or vendors, to business expenses like employee salaries.

After cash inflows and outflows are outlined, total outflows are subtracted from total inflows to get a value for net cash flow. This bottom-line number can help businesses determine when and where liquid funds are being used.

3. Look back

Once you learn how to prepare a statement of cash flows, it's time to use it to begin learning about your business's financial history. Past experience with cash flow can be a sign of a business's solvency and can help to dictate future cash flow actions. Looking back means preparing a cash flow statement covering a set period (for example, the prior quarter ending June 30, 20XX, or the prior fiscal year ending September 30, 20XX). Technically, a cash flow statement tracks income from three sources: operating, investing, and financing activities.

Small business cash flow statements can be easily created through accounting software. The importance of the cash flow statement is not its creation but its analysis.

  • Where is cash coming from each month?
  • What is draining cash each month?
  • How is cash flow changing month over month?

4. Look ahead

After looking backward, it's time to move forward. Make cash flow projections for the next 12 months to help ensure sufficient cash to pay projected expenses. Forecast what you expect sales to be, as well as the sources and amounts of cash to be paid out. Of course, forecasts may not come true, but they are generally a good indication of where the business is headed and whether changes in business practices may need to be made.

Consider using tools to monitor cash flow. These tools look into your accounting solution and keep tabs on your bank balance, due dates of accounts payable, and other information vital to cash flow.

5. Evaluate your financial tracking methods

Now that you have the analysis from looking back and projecting forward using your cash flow statements, take your tracking to the next level by improving your cash flow know-how. To prepare a statement of cash flows effectively, you can get additional clarity by separating out your cash-related business transactions. The most common practice is to separate items into operating, investing, and financing activities.

You can also get more in-depth analysis by learning different methods for preparing a cash flow statement. The two most common methods are:

  • Direct — This method tracks the basic inflows and outflows of operating activities only. It's the easiest to get started for new business owners but doesn't provide quite as much detail.
  • Indirect — This method tracks activities from all three types of cash flow and also tracks depreciation and net income. It's more complicated to learn but provides much better tracking for the business owner.

6. Change customer payment and collection strategies

After perfecting your tracking and analytical methods, you can use that data to identify areas of business operations that could benefit from improved processes. Speeding up the customer collection process typically enhances cash flow. Instead of billing for goods and services, make it easy for customers to pay immediately by check, credit/debit card, or electronic payment options (e.g., PayPal). For example, authorize employees to accept payment on the fly with mobile devices. This will put sales on an equal footing with cash flow.

If you must invoice for goods or services because of industry practices or other reasons, review your collections policies to accelerate payments. For example, bill immediately, rather than at a set time each month. Follow up on delinquencies faster, and don't hesitate to reach out personally to slow-paying customers, observing the rules in the Fair Debt Collection Practices Act.

7. Change business income and expenses

Two ways to improve cash flow are: get more income (inflow of cash) or reduce expenses (outflow of cash). Of course, this is easier said than done. It is essential to review the cash flow statement to discern potential areas in which changes should be made. Then review the business's:

  • Business plan — You may need to make strategic changes to the business, such as adjusting your hours of operation, dropping unprofitable lines or eliminating specific services.
  • Budget — You may want to revise your budget, reducing spending for certain variable costs (e.g., marketing or travel).
  • Customer list — While you may be focused on growing your business by gaining new customers, you may also need to cut ties with customers that create cash flow issues for you by continually paying their bills slowly.

Cash flow sounds simple, but managing it wisely is a complex endeavor. Failure to properly track, analyze, and predict your business cash flows can result in shortages when you need it. A cash shortage can cause problems making payroll, disrupt relationships with your vendors, and result in unneeded stress and frustration. Work with your financial advisor to better understand where you stand with cash flow.

This website contains articles posted for informational and educational value. Paychex is not responsible for information contained within any of these materials. Any opinions expressed within materials are not necessarily the opinion of, or supported by, Paychex. The information in these materials should not be considered legal or accounting advice, and it should not substitute for legal, accounting, and other professional advice where the facts and circumstances warrant.