Back August 15, 2018

The Language of Cash Flow: Activities

Running a small business is one demanding game of whack-a-mole and between all those struggles, the financial one is often the most burdensome. Wondering why your business looks profitable on paper, yet your bank account is saying the opposite? Well, because profit is mainly based on promises, not actual money coming in. But cash, cash is different – if you’re looking at your company’s cash flow statement, you’re looking into your bank account.

Cash is a reality check

Ok, in theory, this should be easy – it’s your company, so you must know what’s happening with it. Yet still, some managers still fail to pay attention to cash and that is mainly because most cash flow statements are hard to read or understand for a non-financial person.

But taking your time to understand cash movements will eventually pay off because you will be able to cut through a lot of future confusion.

The first thing you have to keep in mind is that cash keeps your company up and kicking and cash flow is critical when it comes to measuring its financial health.

You need people to run a business, a place, equipment, supplies and so on — you can’t pay for these with profits because profits aren’t real money. Which leads us to the next point: Profit ≠ Cash. Why? Because cash may come in from different sources, be it a loan or an investment, and that cash is not going to appear on your income statement. Profit always reflects customers’ promises to pay, while cash flow, by contrast, always reflects cash transactions.

Understanding the difference between profit and cash is important, especially because having a healthy business requires both.

Analyze your cash flow the easy way

Now, let’s dive into the cash flow statement. It shows how your company spends its money (cash outflows) and where the money comes from (cash inflows). Thus, it includes all cash inflows your company receives from its ongoing operations and external investment sources, as well as all cash outflows that pay for your business activities and investments during a certain period of time. These inflows and outflows are divided into three main categories: operating activities, investing activities and financing activities.

What each category tells you

Operating activities

This section should include transactions, in and out, from all the operational business activities. Cash-ins from sales of goods and services, cash payments to suppliers and employees, acquisitions of inventory and other expenses – all these will reflect the actual amount of money your company receives from or pays for its operations. A healthy operating cash flow indicates that a company is doing a good job turning its profits into cash. Moreover, it means that it can finance more of its growth internally, without borrowing money or selling more stock.

Investing activities

This category of your cash flow plan generally involves long-term investments, made by the company, not by its owners – in short, anything involving buying or selling company assets. For example, you might want to buy new office equipment such as computers and printers for the new employees – these things are necessary to keep the company running. This kind of investment represents a cash outflow and therefore will have a negative impact when you’re going to calculate the net increase in cash from all activities. Or, let’s say you’re going to sell an asset, the car that your company owns for example. Bear in mind that this is a different type of income, so even if it boosts your cash flow, you can’t count it as revenue due to the fact that this amount of money isn’t coming from your core business activity. This category shows how much cash the company is spending by investing in its future.

Financing activities

The last section of the cash plan will provide you an overview upon cash used in financing activities such as obtaining cash from creditors and repaying the amounts borrowed or obtaining capital from owners and providing them with a return of their investment. If you need to cover your cash flow crunches, you can apply for a line of credit – it can be a good option because it can typically give you access to cash flow financing when you need to cover working capital expenditures or make investment opportunities. Looking at this category over time, you’ll be able to see to what extent is your company depending on outside financing.

Short recap

✓ a company needs profit and cash because while they are different, a healthy business requires both;

✓ the cash flow is the one that keeps the company up and running;

✓ the operating activities from a cash flow statement indicate the company’s ability to internally finance more of its growth;

✓ the investing activities show how much cash the company is spending by investing in its future;

✓ the financing activities show you to what extent is the company depending on outside financing.

Yes, running a business is a tough job and it may be overwhelming sometimes. But here are some good news: there are solutions which can help you analyze your cash flow. Sure, you will have to periodically keep an eye on it, but having the financial information about your company at your fingertips will be useful to you. So take a step back and check your company’s cash flow, see what it tells you and even more than that, try to understand the logic behind it. This way you’ll figure out how you, as a manager, can help your business’s cash position and make some reliable, healthy decisions.

Author: Sorina Miron