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Cash Flow

Cash Flow Statement: The Missing Piece

When a Certified Public Accountant (CPA) prepares a full set of financial documents there are generally three statements:

  • The Balance Sheet
  • The Income Statement
  • The Cash Flow Statement

Most business owners are familiar with a balance sheet and an income statement, but many small and medium businesses have never seen a cash flow statement. To complicate matters, sometimes the cash flow statement is in an indirect format, which can be extremely confusing to translate.

The main reason cash flow statements are omitted is that they tend to take quite of bit of accounting knowledge to produce. However, the cash flow statement is, in fact, one of the most valuable reports a business owner can utilize.

As the name indicates, the cash flow statement is the main report that shows where your cash is spent. What exactly should you look at in your cash flow statement?

Under Generally Accepted Accounting Principles (GAAP), the balance sheet should be produced using the accrual basis of accounting. Accrual accounting is powerful as it allows the business owner to see what is owed at a specific point in time, and what they owe as well.

One weakness of the accrual basis of accounting is that it can distort where a company is sitting in respect to their cash. This statement gets rid of all the noise of the accruals. It presents the actual cash as it flows through the organization--hence the name.

The statement itself should have three categories:

  • Cash from Operations
  • Cash from Investing
  • Cash from Financing

Of the three categories, cash from operations is the most important.

As a former audit principal, I would use the cash from operations as one of my main areas of review. The reason is that the cash from operations section removes any items that could skew the view of the company. It gives a true number as to the cash earned by the organization based solely on operations.

If the number is positive, then the business has earned enough money to pay expenses with a surplus left over. A negative cash from operations says that the business has inefficiencies that, if not cured, could cause the company to struggle or fail.

As noted before, the beauty of the cash flow statement is that it removes all of the accrual ‘noise’. A classic example is in accounts receivable. Say you are coming toward the end of the fiscal year and you have net income of $10,000. Now, lets say you had an increase of your accounts receivable of $13,000 from the prior year.

Are you sitting in a good position at year end?

Assuming no other changes in the balance sheet accounts, the answer would be...no.

Remember, when you have revenue from credit sales, the entry is to increase revenue by the sale but also accounts receivable. However, there is no cash...yet. The company has not collected the money, but can mark it as cash to be deposited in the future.

Even though the organization had a net income, in this example, the change in the accounts receivable would not only offset the net income, but show a loss of $3,000 from operations ($10,000 net income less change in accounts receivable of $13,000). This loss would be reflected prominently on the cash flow statement.

An additional benefit of the cash flow statement is to help identify any red flags for fraud. If, for example, a bookkeeper posted a fictitious sale to elevate net income, the effect on the cash from operations would be inaccurate. During an investigation, a forensic accountant looks to see if the change in net income are comparable to the change in cash from operations.

If not, there is likely an issue that needs further analysis.

You can schedule a complimentary consultation with one of our CPAs at hovlandforensic.com/scheduling.

Steven D Hovland, CPA, Cr.FA

Steve Hovland, a certified public and forensic accountant, Hovland brings to his duties more than 20 years of experience in audit and accounting services as well as forensic investigations. For additional information call (888) 878-0047.

Post Author: Steve