An Introduction to Understanding and Calculating Cash Flow

The movement of cash in and out of your New York City restaurant business is defined as cash flow.  Cash outflows are your company’s expenses and cash inflows are your company’s sources of income.  Let’s look at an example to illustrate these concepts.  Hypothetically, say that you own a bakery.  When your customers purchase goods like pastries, donuts or cookies, a cash inflow is generated.  On the flip side, the ingredients you purchase that are necessary to make these delicious goods qualify as a cash outflow.  The idea is to have positive cash flow– you want to make more money than you spend.

Wanting a positive cash flow may seem obvious, but this thinking is not always so straightforward.  In fact, even established companies which generate profits will usually encounter cash flow issues.  Every business will face certain challenges because every business that aims to generate cash has to balance every aspect of the business- there are many moving pieces.  At any one single point in time, a business needs to monitor regular expenses like rent and employee compensation; however, at that same point in time, most businesses can experience irregularities in their respective cash flows due to the way they are investing or whether or not the said business is seasonal.  There are also going to be times when completely unforeseen events or expenses will hit the books and impact cash. The financial statement that rolls up and summarizes cash flow is called the cash flow statement.  Achieving positive cash flow is one of the most impressive accomplishments in small business. Companies typically report their cash flow through on a cash flow statement.

More on the Cash Flow Statement & Other Reports

Sometimes referred to as a statement of cash flows, the cash flow statement is the paper mechanism by which money in and money out are captured.  Cash on hand is the main way that a company’s liquidity is assessed and determined.  The cash flow statement can provide incredible insight into a business.  If your business is public, you are required by law to release a cash flow statement every quarter during the year.  Normally compiled alongside the cash flow statement are a company’s income statement and balance sheet, both of which also provide great insight into a business’ financial health.  The typical income statement compiles a company’s profit and losses and revenue and expenses.  The most common form of the balance sheet will show a viewer the overall “state of affairs” for a business, as this statement is divided into assets, liabilities, and equity.  Together, these three statements (cash flow, income, and balance sheet) provide a comprehensive view of a business.

Cash Flow vs. Profit 

Cash flow and profit are often confused and many people think they are actually the same thing.  When looked at cash and profit from an accounting or bookkeeping perspective, the two figures are very different.  This difference is most clearly exhibited when one compares the cash flow statement to the income statement.  The clearest cut difference is that the income statement displays numbers based on accrual accounting, whereas the cash basis of accounting is used for the cash flow statement.  Cash accounting is used to track actual cash at the very moment it is exchanged.  Conversely, accrual accounting tracks expenses and revenue at a point in time when they should be incurred.  

A good example to demonstrate this idea is to think of a magazine subscription.  When you place your initial order for a magazine, you ordinarily pay upfront for the full cost of the bill for the term of your subscription.  For simplicity’s sake, let’s assume that your magazine subscription is $120 annually.  Because you paid upfront for the full $120, your cash flow statement (actual cash out the door) will show $120 spent because your check was mailed in and cashed.  Accrual accounting, the accounting method used for your respective income statement, will split the cost of your magazine subscription into incremental time periods.  So, every month, you would document $10 ($120/12 months) as an expense.  An even deeper dive into the difference between profit and cash flow would offer an example where a company is profitable on its income statement but is coming in short on the cash side.  An instance where this might occur would be in a business that relied on invoicing for the collection of payment from customers.  These days, it’s practically the norm for customers to wait a period of time to submit payment.  Accrual accounting (income statement) would show accrued profits, but cash accounting (cash flow statement) would not reflect any immediate cash inflow because your invoice has not actually been paid yet.

Understanding the Cash Flow Statement  

Critical to understanding the cash flow statement is understanding the very basic equation upon which it is founded.  

This equation is: Asset Investments + Operation Costs + Financing = Available Cash

Some definitions are in need here so let’s take a look at what each of these equation components is comprised of:

Asset Investments: The actual cash utilized to buy or sell long-term assets of the capitalist nature is also known as the cash flow from investing activities.  Within this section would be the value of items such as investment securities, equipment, property, machinery and so forth.  In an ideal world, your business would be able to successfully pay for these asset investments with money from normal operating activities.  

Operation Costs: This category is also known as operating cash flow and shows just how much money your business has earned or spent on a daily basis.  Cash received in a specified period combined with collections of sales where credit was used in the same period is taken into account.  The aggregate of these figures, less regular expenses, is your operating cash flow.  This number will give you and other statement viewers a pretty good idea of how much money your core business can generate.  This number is a key metric that you want to see in a growth mode.

Financing: Most important for publicly traded companies, a business’ financing number is where it records cash paid to or received from investors (when applicable) and cash paid to or received from lenders and other relevant creditors.  For those publicly traded businesses, repayment of debt capital, payment of dividends and cash flow from the sale of stocks and bonds is recorded.

The Causes of Cash Flow Issues

It is sometimes more often than not that a company will fail because its cash management lacks a thorough understanding of the difference between cash flow management and making actual money.  After all, we have discussed that it is possible to have cash without a reported profit because of the blurred lines between cash accounting and accrual accounting.

This concept is not as straightforward as it sounds though- more so the issue is that cash flow is not always a fluid and seamless number to report- it is actually hard to predict.  Expenses, on the other hand, are always going to be there and have less of a likelihood of being sporadic and random in nature.  To elaborate, poor sales figures are not in direct correlation to a cash flow issue.  Poor sales are not under the realm of a cash flow problem and can usually be attributed to a product or sales issue.  A cash flow issue, on the other hand, will occur when a business witness good sales but cash from those sales are locked up in accounts receivable, accounts payable or lingering in inventory.  In essence, the cash exists- just not yet.  

This is where having good bookkeeping and accounting teams come into the picture.  These teams can identify when a business’ lack of cash flow is due to a delay in the accounts receivable process.  These teams can help the same business understand how to get paid in a more timely fashion.  And, these are just a few ways that the right bookkeeper can assist a business.  

Conclusion

Really, cash flow issues are most pertinent when the proper bookkeeping and accounting needs are not met.  When a business is asked about its cash flow, it probably needs that answer very quickly. This is where automated real-time systems and services, such as those provided by Bookkeeping Chef, can come in handy.  Positive cash flow is a must and every business is happy when it knows that figure is in good hands.  Contact Bookkeeping Chef for a consultation today!  
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