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Understanding Cash Flow for Entrepreneurs
Of the three important mediums of financial information, a cash flow statement provides the most significant insight into the performance of a business, usage of funds and means of funds. While finance managers are interested in the information provided by the business’s accrual-based financial statements, their primary focus should be on cash flows. It’s important to understand why this focus is required before delving into understanding cash flow statements.
- How does the business fund obligations?
- How does it fund operations and growth?
- How does it compensate owners and investors?
While the above questions keep every business owner awake, it’s advantageous to grasp the basics of cash flow in order to be in control while addressing business challenges.
Every business needs to apprehend three critical components of their daily operations. This should be undertaken on a regular basis – monthly if not daily. These are:
1. What are the operational flows of the business?
a. Inflows on account of sale of assets, investments in securities etc.
b. Outflows on account of purchases of assets, investments in securities made etc.,
2. What are the investment-flows undertaken by the business?
a. Inflows on account of sale of assets, investments in securities etc.
b. Outflows on account of purchases of assets, investments in securities made etc.,
3. What are the additional means of funding other than operational flows into the business?
a. Inflows on account of debt raised
b. Inflows on account of equity raises
c. Outflows on account of debt repaid
d. Outflows on account of repurchase of equity or dividends paid etc.
These three critical components of the cash flow statement are prepared on a periodic basis depending on the dynamic nature of the business. If there are frequent cash flows in or out of the books, then the preparation should be in line with that frequency in order to keep things on a tight leash.
