Accrual based accounting provides for an income statement showing profit as it contains all earned income and the expenses relating to earning that income. However, it doesn’t necessarily indicate that the profit is now in your bank account.
Some investors and business owners believe that “cash is king”. The cash flow statement identifies the cash that is flowing in and out of the company. If a company is consistently generating more cash than it is using, the company will be able to pay down debt, invest in more equipment or increase its dividends.
A cash flow statement is not only concerned with the amount of the cash flows but also the timing of the flows. You may have earned the income, but if you haven’t collected it, the money isn’t available for use. The timing of the cash balance is important, and a cash flow statement may be able to help you know what to expect at the end of a monthly or yearly period. It will also take into account items that don’t impact profit – like the loan payment on capital assets.
Working capital is an important part of a cash flow analysis. It is defined as the amount of money needed to facilitate business operations and is calculated as current assets (cash or near cash assets) less current liabilities (liabilities due during the upcoming accounting period). Computing the amount of working capital gives you a quick analysis of the liquidity of the business – and lenders use this as an indicator of the health of the business.
As a result, savvy business people and investors utilize a cash flow statement as an important financial tool. In a year of growth or change in your operations, this tool is invaluable for planning.
The professionals at White Kennedy can help you understand the financial information related to the health and prosperity of your business.
Written by Marielle Brule, Partner, White Kennedy LLP