Cash Flow Statement

Cash Flow Statement for Your Business Plan

It is a common small-business mistake to look at an income statement and conclude that a business is healthy because it is profitable. A profitable business, particularly a growing business, can still run into serious cash problems. A business that runs out of cash soon goes out of business. That’s why your business plan must include a Statement of Cash Flow.

The statement of cash flow starts by looking at the beginning cash and then makes adjustments for things that happen during the period, which impact cash. Finally, the ending cash is calculated for the month. The current month’s ending cash is next month’s starting cash. Open the sample statement of cash flow and step through it from top to bottom. This example will serve as a template for your own cash flow statement.

The starting point for cash flow is the Net Ordinary Income from the income statement. From there, we’ll make adjustments to track actual inflows and outflows of cash.

Increase / (Decrease) in Accounts Receivable. This adjustment can seem counterintuitive at first. It is easiest to understand using the example of the first month of the new business. The income statement showed revenue of $1,000. Since the amounts were invoiced on terms of net 30, no cash has yet been received. Therefore, accounts receivable increased by $1,000.

On the sample cash flow statement, look at the January “(Increase) / Decrease in Accounts Receivable.” To reconcile net ordinary income to cash, we have to subtract $1,000. The cash flow statement has to show the change in accounts receivable from one month to the next.

In our sample financial statements, we made the assumption that 100% of the previous month’s sales will be collected in the next month, and none of the current month’s sales are collected in the current month. Assumptions such as this are reasonable taken as an average and can be used to forecast this line item of your cash flow statement.

(Increase) / Decrease in Accounts Payable. Just as we made an entry above for changes in accounts receivable, we would have a similar entry for the change in accounts payable. If our accounts payable (bills owed but not paid) increase, we would have to subtract the amount of change to reconcile cash to net operating income. Most new, small businesses are required to pay their bills in the current month. As such, accounts payable stay at approximately $0. All bills are paid at the end of the month. With no change from month to month, no cash flow adjustment is necessary.

Let’s continue with the other adjustments, which are more straightforward.

Deposits and Prepaid Expenses. A deposit or prepaid expense doesn’t show up on the income statement because it is not a current expense. Yet it takes away from cash in the bank. When our sample business signed an office lease, it had to provide a security deposit of $2,000 in February. This isn’t “rent,” it’s a deposit. You’ll see this number again when we talk about the balance sheet. But for now, we need to subtract this amount, $2,000, in February to further reconcile net operating income to cash. You’ll see this entry in February of our sample statement of cash flow under Deposits and Prepaid Expenses.

Capital Purchases. For an understanding of how capital purchases and depreciation work together, read the capital purchases section and the depreciation section together (see below).

When you purchase a piece of equipment, the impact on cash is immediate. However, the full expense only shows up on the income statement over a longer period of time. So once again, we have to make an adjustment to reconcile net operating income to cash. This is a two-part exercise. First we take into account the purchase and then the “depreciation,” which is highlighted below.

To account for the purchase price of the asset, we make an entry for the full cost on the statement of cash flow in the Capital Purchases line. In our sample financials, you’ll see that the business made furniture, equipment or other capital purchases of $12,000 in January, $5,000 in March and $3,000 in August. These are shown as negative numbers because they take away from cash.

Depreciation. When you purchase an asset such as a piece of equipment with a useful life greater than the current year, the government requires the asset to be written off over a longer period of time. You can’t simply create an expense for the full amount in the current period. Why does the government care? They don’t want businesses making large purchases just to reduce taxes. The rules governing depreciation are complex and vary by the type of asset. Here we’re addressing only how depreciation affects cash flow.

In our sample company, our “sample accountant” has calculated a depreciation schedule for each type of asset and told us to spread out depreciation expense evenly over the course of the year at $1,000 per month. On the income statement, this keeps the expense even instead of creating a big hit in a single month. However, this depreciation isn’t a cash expense, it’s just a write-off against taxable income. On the cash flow statement, we have to add back depreciation to reconcile cash to net operating income. See the sample statement of cash flow where we’ve added back $1,000 in each month.

Net Cash from Operations. The sum of the net operating income and the adjustments to reconcile to cash (detailed above) equal the net cash from operations. This is a subtotal on our way to showing the month-ending cash balance.

Financing Activities. Since financing activities (all loans and capital investments) impact the cash flow statement much in the same way, we’ll cover them all in this same paragraph. Each time you receive money for a loan or capital investment (whether by an owner or investor) the proceeds need to show up on your statement of cash flow. Money or “cash” comes into the business and it needs to be accounted for.

While interest on a loan is an expense and therefore found on the income statement, principal repayment is not categorized as an expense. Therefore, to reconcile the income statement to cash, we have to show these repayments on the statement of cash flow. Loan repayments take away from cash and are therefore shown as a negative number on the cash flow statement.

On the sample statement of cash flow, you can see that the business received loan proceeds of $40,000 in January, plus an investment from the owner (Capital Stock) of $15,000 also in January. Then, the company repaid $1,000 in principal each month of the year. These monthly repayments reduce cash.

Net Cash Increase / (Decrease). Continuing down the Statement of Cash Flow, the Net increase / (Decrease) in Cash is the fully reconciled change in cash for the period. In other words, it takes into account net ordinary income, adjustments for changes in accounts receivable, deposits and prepaid expenses, capital purchases and depreciation. Next, the adjustments for financing activities are accounted for as described above. The sum of the net ordinary income and all of the adjustments is the net increase or decrease in cash.

Beginning and Ending Cash. In the sample financial statements, the Ending Cash for January is $37,175. Notice that the Beginning Cash for February is the same amount, $37,175. Beginning Cash for any period is simply the ending cash for the prior period.

To calculate the Ending Cash, you add the Net Cash Increase or Decrease to the Beginning Cash. In other words, take what you started with, take into account the change in the period, and what you have left is the ending cash. In our sample financials, in January the business started with nothing (since that’s the month the business was started), and the Net Increase in Cash was $37,175. Therefore the Ending Cash for January was $37,175, or $0 + $37,175. As you can see, the business took out a loan, received a capital investment from the founder, made some capital purchases, and had a net ordinary loss.