Every business, regardless of whether it is some MNC giant or that small bakery towards the end of your street, needs to manage its cash flow properly in order to survive. Many small companies believe that the statement of cashflow conveys the same information as the income statement. The reality though, is different.
An income statement calculates period results (profit or loss) on accrual basis using the matching concept. This implies that any revenues generated or any expenses incurred during the period go towards the calculation of profit/loss, whether or not the cash is actually received or paid in that period. A cash flow statement, on the other hand, represents the balance between the incoming and outgoing cash during the time period under review, whether or not it relates to that period. For better understanding, cashflows are segregated into three categories – operations, investing and financing.
The first category calculates net inflow or outflow from core operating activities. This excludes non-cash items, such as depreciation and includes taxes. It is important to note that an entity with loss in income statement can still have a positive cash flow from operating activities. Change in working capital also impacts the cash availability and is, therefore, included. The second category deals with investments – capital expenditure – and sale/purchase of assets. A growing company usually has a negative cash flows from investing. Cash flows from financing comprise of long-term funds raised for running the business and payouts, such as dividends and stock options. Cash flow Statement Guidelines under the US GAAP, IFRS and Indian GAAP have minor variations on item classification.
When it comes to managing a company’s liquidity, working capital and cashflow analyses go hand in hand. Poor cash flows often occur in high growth businesses where sales are rising steeply and so is the working capital requirement. Assume a small company’s manufacturing cost for some merchandise as $200,000 and that it has managed to locate a buyer who is willing to shell out $1,000,000. Initially, this appears to call for popping champagne bottles along with several pats on the back. But, what happens if the production related outflows are due in January, but the consumer will only buy the product in May? The company should be able to estimate its liquidity and arrange for necessary funds (long or short term) accordingly. Small businesses are more susceptible to cash flow issues than bigger firms because they either have very little surplus money or none at all.
A successful financial strategy incorporates positive cash flows from operations, informed pacing of capital expenditure and securing required finance at optimum time. It would be a great advantage to have expert guidance on all three aspects from a single source that not only helps you plan, but also assists in implementation. We do exactly that. Please visit us at www.eurionconstellation.com and let us know your requirements.