It’s a common question I get from both individual shop owners and MSOs: “Our profit and loss statement shows we are making money, so why does it never seem like we have enough cash?”
To get an answer to that question requires a financial report called a statement of cash flows. It is a less commonly used report, but it can be helpful because it restates your net income as net cash; this allows you to determine – no matter how much you made or lost in a given period – how your cash situation improved or declined during that time.
The statement of cash flows (SOCF) starts with the net income figure, but adjusts for items that have no effect on cash (such as depreciation, receivables and payables) and for cash items that are only posted to the balance sheet and therefore never impact the net income figure on the profit and loss. Some examples of these types of items include asset purchases, shareholder distributions and receipt of loan proceeds.
By adding or subtracting these items from net income, the SOCF shows the change in your cash situation for the period.
So let’s look at an example (Fig. 1). The profit and loss statement for this hypothetical MSO showed net income of $3,500 (Line 10) for this period. But that doesn’t mean the MSO had $3,500 more in cash. In fact, it’s cash balance actually decreased by $4,500 (Line 10).
| Figure 1 | |||||
| Cash Accts | Accts Rec | Accts Payable | WIP/Asset | Net Income | |
| Beginning balance | 0.00 | 0.00 | 0.00 | 0.00 | 0.00 |
| Cash sales | $2,000 | 0.00 | 0.00 | 0.00 | $2,000 |
| Receivables sales | 0.00 | $5,000 | 0.00 | 0.00 | $5,000 |
| Legal expense | 0.00 | 0.00 | $3,000 | 0.00 | ($3,000) |
| Parts payment | ($1,000) | 0.00 | 0.00 | 0.00 | ($1,000) |
| Work in Progress (WIP) | 0.00 | 0.00 | 0.00 | $500 | $500 |
| Assets purchased | ($5,000) | 0.00 | 0.00 | $5,000 | 0.00 |
| Receivables collected | $500 | ($500) | 0.00 | 0.00 | 0.00 |
| Legal expense paid | ($1,000) | 0.00 | ($1,000) | 0.00 | 0.00 |
| Ending balance | ($4,500) | $4,500 | $2,000 | $2,500 | $3,500 |
The SOCF shows how $3,500 in net income can translate into a cash loss of $4,500. Let’s look at it line by line. A cash sale (Line 2) clearly adds to our cash accounts and net income. But receivables (Line 3) add only to our net income, not our cash accounts. It is only as these receivables come in (Line 7) that our cash situation improves. So in this example, the $4,500 we had in accounts receivable at the end of the period gets deducted from our net income in terms of its impact on cash on hand.
Similarly, even though we showed a total legal expense of $3,000 (Line 4), we only paid $1,000 of it in cash (Line 9), so we have to add back $2,000 to the net income figure to show how cash was really impacted.
The asset purchase (Line 7) is an example of an item that never impacted the net income total but needs to be deducted to show the cash outlay.
Figure 2 shows how the various elements add to or reduce the shop’s cash for the period.
| Figure 2 | ||
| Net income | $3,500 | |
| Adjustments provided by operating expenses: | ||
| Accounts receivable (asset balance increases so needs negative adjustment to net income) | ($4,500) | |
| Work-in-progress (WIP) account (asset balance increases soneeds negative adjustment to net income) | ($500) | |
| Accounts payable (liability balance increases so needs positive adjustment to net income) | $2,000 | |
| Net cash provided by operating activities | $500 | |
| Cash provided by investing activities: | ||
| Fixed assets (asset balance increases so needs negative adjustment to net income) | ($5,000) | |
| Cash decrease for period | $4,500 | |
| Cash at beginning of period | 0.00 | |
| Cash at end of period | ($4,500) |
By reviewing the details of the statement of cash flows, you can isolate specific sources and uses of cash. An analysis can help you determine whether a cash source is sustainable (such as sales and collections) or a one-time event (such as new loan financing) that you shouldn’t plan on consistently.
You also can use the report to help make decisions on where cash should be spent. For example, if you show credit card balances consistently decreasing, that use of cash could be a good thing if you are paying down high balance cards; but if it is causing cash flow problems, you may need to assess if that is where you want to be spending your cash.
With practice and analysis, you can use this useful tool to help manage your business and understand that age-old question, “Where did all the money go?”
