A cash flow statement shows the movement of cash in and out of your operation over a given period of time. It’s different from an income statement or balance sheet in that it’s limited to only showing changes in the cash available to your businesses due to a variety of factors. It is a key document that lenders often look at to help determine the capacity, or the ability of the operation to repay its debts. And while it’s an important document to have on hand when seeking financing for your operation, it’s also a valuable management tool.
The cash flow statement is organized into three sections. The first is operations, which shows money generated and used from the business’s daily activities. This is where a lender will look closest for the indication of capacity. The second is investing activities, which would generally be the sale or purchase of capital assets. For example, buying a tractor would be recorded as an outflow of cash while selling a tractor would be an inflow, even if you sold the item for less than you paid, and incurred a loss on the sale. In this way, the cash flow statement is very different from the income statement. It doesn’t tell you whether you are earning a profit or not – instead it tracks the availability of cash. So while the income statement is important for tracking the overall performance of your business, the cash flow statement is important for tracking your ability to pay bills and “keep the lights on.” It’s not unusual for a business to be profitable, yet have cash flow issues.
The third section is financing activities. This section shows the impact of financing activities on cash available. Money in would be a new loan or a line of credit disbursement, while money out would be principal and interest payments on existing loans.
Expenses & Your Operation’s Life Cycle
The cash flow statement can tell someone quite a bit about your spending habits or the maturity of your business. Typically, new businesses have a more difficult time showing a positive number in the operations section. At this stage, a business might not yet have reached a critical volume of sales, or it could be spending cash to generate inventories to sell at a later date. A more seasoned business might have taken on more debt to finance an expansion, so you might see a net positive from operating but a net negative from financing activities. It’s important to consider that cash can ebb and flow for reasons both good and bad, so keep in mind that a negative change in cash on the cash flow statement may not necessarily be bad. It could indicate you are paying down debt, for example.
The stage of maturity of a business may not be the only driver of differences between cash flow statements among companies. It also matters what management style your business has and the industry you are in. Farmers in many sectors finance inputs ahead of the growing season, during a time of year when they are not generating cash from earnings. At certain parts of the year their cash flow statement may make it appear the business is performing poorly.
This makes it critical to examine your cash flow statement alongside your income statement and balance sheet in order to paint the clearest picture of your financial position. Having more cash on hand is good, but not if you’re over-leveraging yourself through financing in the name of preserving that cash. On the other hand, having too little cash on hand may be a recipe for disaster, even if your business is profitable on an accrual basis.
Timing Is Everything
The timeframe examined in a cash flow statement and how that timeframe corresponds with sales and expenses incurred will have a major influence on the story that statement tells.
For example, if you operate a dairy, milk sales are generally consistent throughout the year. However, if you operate a flower farm, your cash inflow may be punctuated by seasonal trends. So, if you compared a monthly cash flow statement of each, they would look very different depending on the time of year. Neither is necessarily bad, but it’s critical for the flower grower to plan for cash flow during the slow periods.
Why Keep Track Of Cash?
Why keep a record of your operation’s cash movement? A cash flow statement is one of the documents lenders typically look at when a producer is seeking financing. A lender needs to see a proven record of being able to meet debt obligations through adequate revenue. Depending on the payment schedule, a producer’s cash flow statement can be the best indicator of his or her ability to make regular payments.
Another reason to keep a good record of your operation’s cash flow, especially if you’re a younger or beginning producer: business projections. If you don’t have a long track record of financing and repayment, projecting future cash flow based on realistic plans or growth your operation is undergoing can go a long way toward procuring financing both today and down the road.
What if you generate a cash flow statement and it doesn’t exactly show the best news? During a downturn in ag markets, a weaker cash flow statement can be explained, especially if it’s due to tough market conditions. In fact, it can be a good budgeting tool to have in down cycles to get a better idea of any cash shortages and what you might be able to do in both the short and long term to fill any gaps you have.
A cash flow statement is just one of several documents that can help you track your operation’s finances. If you have any questions on how to build one or what it means to your operation, contact your local Farm Credit East representative.