Any business needs cash to run. In simple words, cash flow shows the amount of money coming in (cash inflows) and money going out (cash outflows). The funny thing is that a business can have great profits but become cash poor or what is called a negative cash flow. A good example is when the profits go to pay huge loans, leaving little to pay for other expenses.
Cash inflows and outflows
This is all the money that is coming into a business. This could be an investment, loan, customer payments, or interest on loans. Cash outflows include all money that is going out of business including rents, salaries, and loan repayments and so on. The difference in these two is shown on a cash flow statement.
When the cash inflows are greater than cash outflows, the business is said to have a positive cash flow. When it is vice versa, the business has a negative cash flow. A higher positive cash flow gives the business the space to expand, open new premises and so on.
Cash flow statement vs. profit and loss statements
A profit and loss statement shows the total sum of the difference between profits and assets. A business could be making good profits as shown by a profit and loss statement but stay cash poor. This happens in the case of a large portfolio of fixed assets, or when a business has huge payments going out regularly.
On the other hand, a cash flow statement gives a truer picture of the health of a business. It shows exactly where the money is coming from and the ways this cash is being spent. It will show that most of your payments, for example, are coming from credit card sales. It will also show if you are spending money on more inventory or going to car maintenance and repairs.
Key Performance Indicator
A cash flow statement is a useful Key Performance Indicator for a business. It tells you when the business is creating cash, and when it is losing cash. The simple fact is that a business that is creating cash is healthy and likely to expand.
Analyzing a cash flow statement can also help a business identify revenue channels that are more lucrative than others, which would help make a decision whether to grow those channels or put more effort to improve the lagging channels?
A cash flow statement is one of the documents that any investor or lender will want to see. It tells them whether the business has the ability to make regular payments. It is one of the determinants of how much investment or lending a business will get.