Show me the money (on the statement of cash flows!)

Why should a business owner care about the statement of cash flows?

Between March 15 and April 15 each year, I see the following subject line (or one similar) in my email inbox at least once:

HELP! Something is wrong with my P&L!!!

I know what the email will say before I even open it. The business owner who wrote the email has just met with their tax preparer. They have a tax liability. A BIG tax liability. But something must be wrong, because their P&L shows a profit much greater than their bank account balance at the end of the previous year.

Sometimes the business owner blames QuickBooks. Sometimes they blame their bookkeeper, and sometimes I am the bookkeeper they blame. Regardless of who or what the business owner blames, they are convinced something is wrong with their books.

I email the business owner back with a link to my schedule so we can arrange a time to review their statement of cash flows.

Wait. Their statement of what?!

The three key financial statements: A brief review.

Every business owner knows what a P&L or income statement is. Many also realize they should be reviewing their balance sheet, too. I have yet to meet a small business owner without an accounting background who has heard of the statement of cash flows, much less ever reviewed it.

This is unfortunate, because this one little financial statement will answer every question about where a business’ money went.

Most business owners assume all their financial activity appears on the P&L. At first glance, this certainly appears to be the case. However, there are certain – often very large – outlays of cash that do not appear on the P&L. These outlays of cash include asset purchases, loan and credit card payments, and owner draws. Similarly, certain cash inputs – like a capital infusion by the business owner or investors – do not appear on the P&L, either.

The business owners who understand the balance sheet know the numbers relating to this sort of activity appear on that financial statement. They may even pull their prior year balance sheet and build a spreadsheet to try to figure out how much cash got “buried” on it. This can lead to frustration, especially if they have financed some of their assets or capital improvements.

Enter the statement of cash flows.

What is the statement of cash flows?

In short, the statement of cash flows reconciles your financial activity to your bank account balance. This reconciliation is done on an accrual basis, so if your accounting system is set to produce cash basis statements you will need to change this setting.

The very first line on the statement of cash flows is Net Income. Check Net Income on your P&L – again, on accrual basis – for the same period as the statement of cash flows you are reviewing. The two numbers will match.

The remainder of the first section of the statement of cash flows shows balance sheet activity. Depending on your business, you will see changes recorded for Accounts Receivable, Accounts Payable, Payroll Liabilities, Credit Card activity, etc. Following this activity, you will see changes recorded for investing activity (this would be money put into the business) and draws and distributions (money removed from the business.)

The last section of the statement of cash flows is where you see the magic happen. The last few lines will show you your net cash change (increase or decrease) for the accounting period. This is the sum of all the changes shown in the preceding sections of the statement of cash flows. Next, you will see your beginning cash balance for the period. Verify this by adding up all your bank account balances as of the end of the preceding accounting period. You can find these numbers on your balance sheet…remember to set it to accrual basis!

The very last line of the statement of cash flows will show you your cash at the end of the accounting period. Add up all your bank account balances as of the end of the current accounting period, making sure to allow for uncleared checks and deposits, and the sum should match the last number on the statement of cash flows.

Oh, oh, it’s magic!

Actually, it’s math. But to a numbers geek, they’re pretty much the same thing.

Many business owners resist looking at their financial statements on an accrual basis. They think since their taxes are done on a cash basis, that’s all they need to review. This makes me sad. Accrual basis statements give a more accurate picture of a business’ financial standing. But even if you continue to only review your financials on a cash basis, the statement of cash flows can help you determine where your money went. You just don’t get the beautiful reconciliation you can clearly see when you review accrual basis statements.

Your bookkeeper or accountant should be including the statement of cash flows with your monthly financial statements, especially if they are providing you with accrual basis statements. If you find they aren’t, ask them for it. And if you are having trouble understanding the statement – it can be tricky to decipher – ask them to explain it to you. They will gladly do so. None of us like to get panicked emails or phone calls from our clients after they have visited with their tax preparer.

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