Why are the Cash Flow Statement and Cash Flow Management so important in Business?

In the above video, we discuss the Cash Flow Statement and financial models as major components of financial and business management.  We also discuss the differences between the Cash Flow Statement and Income Statement (or Profit and Loss statement, or P&L).


Why the Cash Flow Statement is important

We’re doing this video because of the misunderstandings surrounding the Cash Flow Statement experienced by many business owners and managers and their overreliance on the Income Statement as a financial management tool. While the Income Statement is a very important and useful report, it’s only one part of a complete financial management process as it provides only part of the full financial picture of a business.

The Income Statement provides information about the profitability of a business; however, it doesn’t tell us much about the cash position or needs of the business. That’s where the Cash Flow Statement comes into play, to provide the crucial information needed for effective cash flow management which is a necessary activity for ensuring the current and future solvency of the business.  This is even more important today given the impacts of the pandemic on most businesses and the need to manage cash and solvency carefully.


3 Reasons why the Cash Flow Statement is different from the Income Statement

Within the Cash Flow Statement, there is a section called Cash Flow from Operations which should be used to understand the uses and proceeds of cash by the operations of the business.  This section of the Cash Flow Statement differs from the Income Statement due to the following reasons:

  • Timing of cash payments: Say, you have a customer, and you sell them some product. When you issue an invoice to that customer you record that sale on your Income Statement as revenue, but that customer may not pay you until 30 days later. Because cash is not received right away, the amount of that invoice is reversed until payment is made.
  • Depreciation and Amortization: Depreciation is a non-cash expense that’s recorded on the Income Statement, but because it’s a non-cash charge does not impact Cash Flow from Operations.
  • Non-operating items: These are items that occur occasionally in a business but they’re not a part of its day-to-day operations and are therefore removed from Cash Flow from Operations.


The components that make up the Cash Flow Statement

  • Cash Flow from Operations: As mentioned earlier, this section of the Cash Flow Statement allows you to understand exactly how much cash was generated (or used) by the core operations of your business.  For example, if you operate a bookstore, it shows you the amount of cash generated by your day-to-day operations of running the book store, paying rent, paying salaries to your staff, purchasing books, and selling those books to customers.
  • Cash Flow from Investing Activities: This shows you the uses and proceeds of cash due to purchases and sales of assets. For example, if you purchase a piece of hardware for your business, you will see cash outflow in this section.
  • Cash Flow from Financing Activities: Deals with items such as taking out and paying back bank loans, receiving capital from owners, or paying out dividends to shareholders.

These three components when added together make up Net Changes in Cash, which is exactly the amount of cash that your business created (or used) during a certain period.  For example, if you are looking at your Net Changes in Cash for the year 2020, this amount should exactly match the difference between your cash balance at the end of 2019 and 2020 as seen on your Balance Sheet (or in your bank account).


How a financial model can help with cash management

A very useful tool for managing your cash flow is a financial model like the one presented in the video above. This was a financial model that we created to allow projecting cash flows into the future. A robust and flexible financial model will allow you to project your cash flow and use scenario and sensitivity analysis to model various conditions of your business and plan for your cash flow needs accordingly.



We hope we were able to demonstrate how important it is to look at your business’s Cash Flow Statement alongside your Income Statement on an ongoing basis.

At the end of the day, the solvency of your business is determined by its ability to meet its financial obligations and the Cash Flow Statement is the report that tells you whether you have the cash resources to do just that. Additionally, a powerful financial model can help you to project your cash flow needs so that you don’t run into cash flow problems in your business.

Get in touch with us if you’d like to learn more about financial models or how to build a useful one for your business.

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