Is Your Firm's Cash Flow Healthy?
Posted 9-29-2011 | By Cathy O’Brien | Download Article
Did your professional service firm generate cash flow this month? Do you know where to look to find out? If you are unsure of the answers to these two questions, consider adding a statement of cash flows in with your monthly financial analysis. For professional service firms using the accrual method of accounting, the month-end analysis of your financial statements may be missing this important report.
Cash flow analysis is not monitoring the balance in your cash accounts. Don't fall into the trap of thinking if cash is high, business is good; and when cash is low, business is bad. The fact is, profitability and cash flow are often inversely related. How is this possible? There are transactions such as officer draws and debt principal payments that deplete cash but do not show up on the income statement.
The process of identifying cash flow issues starts with the preparation of a statement of cash flows. Although the statement of cash flows is one of the main financial statements, for many professional service firms this statement is typically not prepared with the balance sheet and statement of income each month. Some owners may feel that a statement of cash flows is not necessary for small firms; others may not know it exists. However, the statement of cash flows is beneficial to any size company.
This statement helps identify underlying cash management issues. It is important to know your cash flow issues and optimize cash balances on a continual basis. Implementing cash flow improvements is a good place to start because it is the easiest area to make changes without a lot of effort.
The key to understanding a statement of cash flows is to understand its purpose and its use in analyzing the change in cash. The statement of cash flows is broken into four sections:
- Operating - This section converts the items in the statement of income from accrual to cash basis. When using the indirect method, this section starts with net operating income; then adds non-cash items such as depreciation and amortization; then adds changes in current assets and liabilities. This section is where the firm's main cash flow should be generated.
- Investing - This section reports the cash effects of purchasing and selling long-term assets such as property, plant and equipment.
- Financing - This section reports the cash effect of borrowing and repaying long-term debt and changes in stockholders' equity accounts.
- Supplemental Information - This section discloses the amount of interest and income taxes paid. It also details exchanges not involving cash, such as assets purchased with financing or an exchange of stock for a company bond.
The key concept is to generate cash flows from operations that sustain business goals. Businesses need capital to grow and prosper, however if the firm is not generating income and cash flows from operations, it makes it difficult to pay down debt and purchase long-term assets. There are ratios to utilize when reviewing your statement of cash flows: cash flow yield and the cash burn rate. These ratios help educate owners on the strength of their current cash flow and the likelihood of meeting fixed commitments.
Sustaining a healthy cash position leads to growth opportunities. Adding the statement of cash flows will help you reduce the risk of putting your firm in a cash-strapped position; analysis of the statement will provide you with early detection if underlying cash management problems exist.
For more information, please contact Cathy O'Brien, MBA, CPA, at cobrien@hlbtr.com.