Know It All, Boss? The Basics of Cash Flow Management

February 26, 2020


Cash flow management basics

mAccounting knows that a CEO cannot be expected to know everything about accounting. At the same time, an effective CEO needs to know enough about cash flow and cash flow management to get the best analysis and strategic support from a controller.

This article is made for a CEO who wants to understand the basics of cash flow management, in minutes.

Here’s what you’ll find in this article:

  • Two Must-Know Concepts of cash flow management
  • Elements of a Cash Flow Statement
  • Resources for Further Reading

One more thing. This article is intended to be a quick primer that won’t turn you into an insufferable know-it-all boss.

Must-Know Cash Flow Concepts

mAccounting believes that the best way for businesses to avoid cash flow problems and ultimately become profitable, is through informed and supported cash flow management.

The concept is really all in the name: cash flow management. It is the practice of monitoring net cash flow for a specific period of time (i.e. a month or a year) to ensure that your business is able to meet its obligations. A controller’s role is pivotal to managing and forecasting cash flow as the controller oversees all accounting activities including financial statements, payroll, budgets, cost accounting, and especially accounts payable and accounts receivable.

As with anything as dynamic as cash flow, there is a possibility for a positive and a negative state of flow.

A positive cash flow signifies that the accounts receivable are greater than the accounts payable. Positive cash flow is preferable but not always possible. Positive cash flow is particularly tough to maintain for businesses in cyclical sectors (i.e. real estate and not-for-profit); when the financial market tightens; and during times of expansion for a business.

A negative cash flow indicated that your inflow of cash is not meeting your outflow of cash. To get a clearer picture of cash flow, a controller estimates how much of the accounts receivable (unpaid goods or services rendered) will actually come in as cash. Prolonged negative cash flow is a common cause of bankruptcy for businesses.

Effective management of cash flow indicates more than just the ability of a business to pay its bills. Cash flow management is a practice that provides a clearer picture of your business operations, investment activities, and financial activities. Understanding what a cash flow statement reflects about your business is critical to developing a plan before, during, and after an unforeseen event.

You cannot be a know-it-all boss without knowing the elements of a cash flow statement.

Elements of Cash Flow Statement

What does a cash flow statement tell you about your business? A lot. A cash flow statement (also called a statement of cash flow) is one of three financial reports indicating the health of a business.

The income statement (also called profit & loss statement or P&L) is the total picture of revenues and expenses over a given period that is rolled into the balance sheet. The balance sheet is a historical overview of a company’s assets, liabilities and owner’s equity. We look to the cash flow statement for the activities behind increases or decreases on the balance sheet, and typically, the net income on a statement of cash flow is derived from the P&L.

A cash flow statement elements show where the money is coming from (cash in) and where it is going to (cash out). The statement tells us whether or not operating costs are being covered by investing and financing activities. It makes clear if the cash flow is positive or negative and where the problems are.

A basic cash flow statement is divided into three business activities (top to bottom):

  • Operating activities: revenues, expenses, gains, and losses not related to investing or financing.
  • Investing activities: fixed-asset (property, plant & equipment) and other long-term asset activities.
  • Financial activities: long-term liabilities, stockholder equity, and owner’s equity-related activities.

The statement concludes with net cash flow. There are two methods for calculating the net cash flow that only affects the operating activities section of the statement: direct and indirect method.

Keeping to our goal of just the basics for this article, we’ll be brief about accounting methods. The main difference between the direct and indirect method of calculating operating activities is that non-cash items (credit or depreciation) are not included in a statement of cash. In the case of the indirect cash method, revenue includes credit for goods and services and not payment, which then, has to be reconciled to cash.

The direct method records all transactions on a cash basis for a given period. Though this may seem more straightforward, and therefore an easier way to calculate total cash from operating activities, it is not preferred by business accountants. This is in large part because the Financial Accounting Standards Board requires a reconciliation report that is similar to the indirect method if a direct method is used.

Get Into Cash Flow

The core competencies of a CEO are different than those of a controller but they also need to be complementary. As a CEO, learning to speak cash flow with your controller will go a long way toward reaching optimal analysis and management of your company’s cash flow. To get into cash flow a bit more than you have here, consider the following easy-and-quick reads.

Tips for Cash Flow Management

  • mAccounting’s own blog article on the FOUR ESSENTIALS gives you straight talk from a CPA on cash flow.
  • Inc.com covers accounting topics, including cash flow management. In Inc.com’s meatier article on cash flow management.
  • The Balance Small Business offers cash flow management tips that include accounting software suggestions and recommendations for accounting software by business type.

Instruction on How to Build Cash Flow Statements

  • The Kaplan Group has an easy-listening, 9-minute tutorial on cash flow statements for beginners on their YouTube channel.
  • A 4-minute video tutorial from Khan Academy might be just the thing for visual learners that want to better understand how the basic cash flow statement relates to the balance sheet and the income statement.

mAccounting believes that the best way for businesses to avoid cash flow problems and remain nimble and able to pay your bills is through informed and supported management. mAccounting is at the forefront of accounting’s future as a value-added service and a trusted advisor.

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Want more accounting basics in brief? Check out an overview of forecast accounting for CEOs, here. Let us know what topics in accounting you would like us to provide in brief by emailing your accounting topic to us at info@maccounting.com or tweeting it to us @GOmACCOUNTING.