Financial Statements: What’s the Most Important Statement You Can Review?

Each time we review a financial statement with our clients, they inevitably turn right to the Profit and Loss Statement (P&L, or Income Statement) and look to the “bottom line”.  While this statement is very telling, there is another financial statement that may be a better indicator of how the company is doing.

What statement is that? It’s the Statement of Cash Flows

The Statement of Cash Flows really shows how a company has managed their cash through a period.  There are three sections to the Statement of Cash Flows – Operations, Investments and Financing.

A company could have incurred a Net Loss and the business owner may not understand how they funded those losses; or the company could have a Net Profit and wonder where did the profits go?  The Statement of Cash Flows provides these answers.

  • Cash Flow From Operations. The top line will be the Profit or Loss for the period, and this is adjusted by changes in Assets & Liabilities that may have generated cash or used cash in a number of ways – totaling to Net Cash Provided or Used in Operations.  The business could have generated cash through profits, collection of accounts receivable, selling of assets (inventory) to name a few. And they may have used cash from Operations to paydown Accounts Payable or other Current Liabilities.
  • Cash Flow from Investments indicates any cash flows related to the purchase of Property & Equipment.
  • Cash Flow from Financing will show how the company may have generated cash through funds borrowed on a Line of Credit or used cash to pay down that Line of Credit.  It would also show borrowings or payments on Term Debt as well.

Each of these sections shows the business owner what they did with the cash – hence the name, the Statement of Cash Flows! It also allows the reader to understand areas of strength, or areas that need improvement related to cash flow.  For instance:

  • Is the company experiencing slow paying customers which in turn hurts cash flow?
  • Is the company experiencing negative cash flow because they are investing in future growth?
  • Is the company funding operations through vendor debt?
  • If the company has negative cash flow from operations, they may be offsetting this through excessive debt.  If so, this isn’t a sustainable way to operate.

There are many other signs to look for through the use of the Statement of Cash Flows.

So the next time you sit down with your CFO to review financial statements, pay close attention to the Statement of Cash Flows to really analyze how the company funded profits or losses for the period.

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