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“Always and everywhere, what is valuable is rare or requires great effort to obtain; what is cheap is easily obtained with little effort.”
Adam Smith
The measurable value structure of a business and the unit of measurement for business size is money, and managing money is the second most important factor for an entrepreneur after the business idea. For this reason, the cash flow statement is one of the most important financial statements for businesses, published alongside the balance sheet and income statement. Cash flow, one of the most critical factors for a business’s survival and growth, is a mirror reflecting the company’s financial health.
What Is the Concept of Cash Flow?
Cash flow is the amount of cash entering and leaving a business/company. Businesses receive money as income from various sales and spend money on expenses. They can also generate income from interest, dividends, investments, royalties, and licensing agreements, and may sell products on credit (with deferred payment) hoping to receive the money later.
Evaluating the amount, timing, and uncertainty of cash flow, along with its sources and destinations, is one of the main objectives of financial reporting. Additionally, a cash flow statement is necessary to assess a company’s liquidity, flexibility, and overall financial performance.
Cash flow or cash flow projection estimates incoming and outgoing cash based on past business performance. Even if sales are strong, a business may face cash shortages. It is essential to collect sales on time and ensure sufficient cash reserves for expenses until payments are received. Moreover, having a contingency plan ready in any extraordinary situation is important for business continuity.
In cash flow forecasting, instead of ignoring credit sales, accounts payable, and accrued expenses, the focus is on actual expected revenue and actual expenses to be paid during a certain period. Past cash flow statements can also be used to forecast expenses for the projected period.
From a financial statements perspective, profitable companies can still run out of cash if they do not manage both profits and cash. For example, certain expenses not reflected in the income statement, such as inventory costs, debt repayments, and new equipment or asset purchases, reduce cash but do not reduce profitability. Therefore, a business may appear profitable while spending money. Likewise, payments from domestic and international sales recorded as income may not be collected immediately. They do not appear in the bank account until the customer pays. Therefore, cash flow forecasting is very important. This forecast helps predict how much money will be in the bank at the end of each month, regardless of how profitable the business is.
Why Is Cash Flow Important? Cash flow affects not only liquidity but also a company’s growth potential, investment decisions, and debt management.
There are several methods for cash flow forecasting, such as the Direct Method and the Indirect Method. These involve creating a cash flow statement for businesses with additional information and commentary based on historical financial statements. As S. Can Karaşıklı states in his book “Find Me a Good Financial Officer”, “Cash is King,” and unlike other financial statements, cash flow statements are dynamic.
What drives companies to halt operations and enter bankruptcy is the inability to pay debts due to disruptions in cash flows. Three fundamental points are critical for business liquidity:
· Management of Operational Working Capital
· Tracking Current Cash Flow
· Establishing Funding Options in Advance to Finance Any Cash Shortfalls
While weekly cash flow statements are recommended for current cash flow, preparing daily cash flow can be more useful for tracking real payments and receipts.
At its simplest, the table should be prepared at the beginning of the month with cash inflows listed at the top, cash outflows at the bottom, and banks holding the cash at the very bottom. Based on the previous month’s cash flows, estimated income and expense items can be included in the table, and a projected budget can be incorporated for ease of use.
The most important point when preparing a forward-looking cash flow statement is to anticipate that planned cash outflows may occur on time, while planned cash inflows may not.
In conclusion, regularly monitoring your cash flow statement at both individual and corporate levels will ensure that your financial management is built on a strong foundation and will guarantee the long-term success of your business.