Measuring Cash - ABC's of Small Business

Cash: How can you measure
something that never stands still?

There is definitely nothing quite as harmful to a small business than to experience a shortage in cash. There are varying opinions regarding the best ways to measure cash and cash flow. Business owners and accountants constantly work to find better ways to report the effects of everyday business on your cash situation. In fact, there are so many ways to examine it that the terms have become numerous and confusing. In this article I will help you to understand some of the terms used in a typical Statement of Cash Flows.

Cash vs. Cash Flow

  From Merriam-Webster's Collegiate Dictionary:
  Main Entry:
  1cash Pronunciation: 'kash
  Function: noun
  Etymology: modification of Middle French or Old Italian;   Middle French casse money box, from Old Italian cassa,   from Latin capsa chest Date: 1596
  1 : ready money
  2 : money or its equivalent (as a check) paid for goods or       services at the time of purchase or delivery

As indicated in the Merriam-Webster's definition, cash is the resource itself. It is used most commonly as legal currency, checks, money orders, and the like. Cash Flow, on the other hand, is a measure of the activity of cash. You can't spend Cash Flow.

Cash Flow is typically measured by analyzing the amounts of cash received versus the amount of cash paid out. (This analysis is customarily followed by agonizing over the fact that the outflows are larger than the inflows!) Look at where your cash comes from and find out where it's going. The report most often used for this in CPA circles used to be called the "Statement of Changes in Financial Position." Since that title was rather non-descriptive to most people it was changed to the "Statement of Cash Flows." Ask your accountant or CPA to prepare one for you.

Let's review the components of the Statement of Cash Flows:

We begin with the Net Income. You'll find this figure at the bottom of your Income Statement (sometimes call the Profit & Loss (P&L) Statement). We start with this figure because it already reflects all of your income and expenses. All we need to do is make a few adjustments to find out how this activity actually affected your cash.

Depreciation. We add this back into the net income figure (it was included in your expenses in the Income Statement) because it never affects your cash situation. It is purely a non-cash transaction. It is used primarily for tax purposes, however, CPA's also use it to help reflect the "true" financial outlook of your company. This introduces the type of accounting we commonly call "accrual".

Changes in assets and liabilities: "Accrual accounting," simply put, is the type of accounting for your finances that records your income as your sales occur, not when you receive the cash. On the other side, your expenses are recorded when they occur, not when you pay them. So you see, much of the reconciliation of your net income to your cash comes from unwinding the timing differences from the actual cash transactions from your accounts receivable and accounts payable. By adding and subtracting the appropriate changes in these asset and liability accounts, we end up with the net effect of the cash inflows and outflows on those items. When reporting cash, items in (parenthesis) mean the number is negative (This applies only to cash and other asset accounts). I realize these adjustments can look intimidating, but they represent fairly simple mathematical logic. Follow as best you can and ask your accountant or CPA to answer your questions. That's what you pay them for!

Cash Flow from investing activities: Investment activities normally refer to anything in which your company would invest: equipment, real estate, stock, or other assets. This category would reflect both the buying and the selling of these assets.

Cash Flow from financing activities: Financing activities refers to the making and receiving payments on loans, both payable and receivable. It can also refer to the purchase and sale Treasury Stock.

Net increase in cash and cash equivalents: This figure represents the sum of each of the sections we've analyzed. We've taken all of your financial activity and squeezed the cash portion of it out so we can see it.

Beginning and Ending Balances of cash and cash equivalents: Once we have our net increase or decrease in cash we can add it to our beginning cash balance and, Presto, we have our new cash balance at the end of the year.

Supplemental Disclosure of Cash Flow Information: CPA's often include this section to show amounts that were reflected in the Net Income figure that were expensed against interest. On occasion a CPA may also separate out cash paid toward taxes (if you are a C Corporation). This doesn't change the cash flow position as stated in the report. It's merely an informational addition to help you better understand how your cash was spent.

Here is an example of what your Statement of Cash Flows might look like (amounts are fictitious):

Your Company, Inc.
Statement of Cash Flows
Year Ended December 31, 2000

Cash Flows from Operating Activities
Net Income		$ 55,000
Adjustments to reconcile net income to Net cash provided by operating activities:
Depreciation	7,000
Changes in assets & liabilities:
(Increase) in accounts receivable	(20,000)
Decrease in other current assets	2,000
(Increase) in prepaid product costs	(3,000)
Increase in deferred revenue	35,000
Increase in accounts payable	2,500
Increase in royalties payable	14,000
Increase in accrued expenses	20,000
Net cash provided by operating activities		112,500
Cash Flows from Investing Activities Purchase of Equipment	(75,000)
Net cash used in investing activities		(75,000)
Cash Flows from Financing Activities
Proceeds from notes payable	100,000
Payments on notes payable	(80,000)
Purchase of Treasury Stock	(45,000)
Net cash used in financing activities		(25,000)
Net increase in cash and cash equivalents		12,500

Cash and cash equivalents Beginning		15,000
Ending		$ 27,500
Supplemental Disclosures of Cash Flow Information
Cash payments for: Interest*		$ 16,000
*See Accountant's Reports

Your Statement of Cash Flows may not look this complex. (It may not look this positive, either!) On the other hand, it could be more complex. It all depends on what your business is about and how many subtle financial transactions commonly happen. Most small businesses are fairly simple with a few complex situations thrown in every 2 or 3 years as you upgrade equipment or buy new property.

It makes sense to evaluate your Statement of Cash Flows in combination with your Income Statement and Balance Sheet over a period of 3 - 5 years. Often you can spot patterns in your spending that can help you with your management decisions.

In my next article I'll share some information with you to help you understand how much cash you need on a regular basis to stay in business. There is definitely some math involved here, so be prepared with your thinking cap on!

-A. Kris Bell