If you’ve read any of the stuff I write about cash being king in your business, you’ve also heard me talk about the term cash flow from operations. A question I often hear is what is cash flow from operations.

So the easiest way to look at whether you’re creating cash or you’re using cash is just to look at your bank balance. Now, if your bank balance is growing, you would think you have cash and if your bank balance is shrinking, you would think that you’re eating cash. Well, that might be true and it might not be true. So let’s look at what a cash flow statement is, how you build one, and we’ll show you sometimes where it might not be true.


Transcript

If you’ve read any of the stuff I write about cash being king in your business, you’ve also heard me talk about the term cash flow from operations. A question I often hear is what is cash flow from operations. It’s really pretty simple. Cash flow from operations is how much cash your company either produce or eats in a particular period.

So let’s take an example. Let’s say we start the year with $25,000 in cash and we end the year with $50,000 in cash. That would mean our company created $25,000 in free cash flow. The opposite is true is well. If you start the year with $50,000 and ended it with $25,000, you would have seen a decrease of cash flow from operations of $25,000 which means you have $25,000 less money at the end of year than when you started the year. Now, this can be a problem. Today, we’re going to dive in to the term cash flow from operations, tell you what it really means, how to figure it out, and why it’s important to you.

Hi, I’m Josh Patrick, the founder of Stage 2 Planning Partners and the Sustainable Business. I also am the one who’s responsible for putting together our Cracking the Cash Flow Code Program. I’m also the author of Sustainable: A Fable About Creating a Personally and Economically Sustainable Business.

So let’s jump right in and take a look at how cash flow statements are put together, and as we’re going through this, we’re gonna talk about why it’s so important for you to understand the different components of your cash flow statement.

It’s simple. Without cash, your business isn’t gonna run. Without cash, no one’s gonna sell you stuff, and without cash, your business won’t be able to operate anymore. Along my business career, I’ve come this close to completely running out of cash several times and several times, I’ve had lots and lots of sleepless nights because I didn’t have enough cash.

Now, the first time this happened to me was because I just had no idea what the difference was between a profit and loss statement and a cash flow statement. Now, a profit and loss statement is what everybody looks at when they say, is my company healthy or not. Well, many times, that will actually give you a good read of whether you have, you’re doing well or you’re not doing well. But there are times where that couldn’t.

I’m gonna show you an example of exactly how that could happen. So the easiest way to look at whether you’re creating cash or you’re using cash is just to look at your bank balance. Now, if your bank balance is growing, you would think you have cash and if your bank balance is shrinking, you would think that you’re eating cash. Well, that might be true and it might not be true. So let’s look at what a cash flow statement is, how you build one, and we’ll show you sometimes where it might not be true.

  • So let’s say we start with a cash balance and a check book of $25,000.
  • Let’s also say you had a profitable year. You made $50,000 on your profit and loss date. So first thing we do is that we add that $25,000 and $50,000 together.
  • The next thing we do is we take a look at what’s called non-cash expenses, and these would be depreciation or amortization. And let’s say your depreciation for the year was $10,000. So we’re gonna add $10,000 to that cash pile.
  • Now, any money that you borrowed during the period also creates cash, and in this particular period, we borrowed $30,000 worth of cash. So now we get to add $30,000 to that cash statement.
  • And if your inventory increases, what you have to do is you have to subtract the increase from cash. Why? Because when you buy inventory, it eats cash. If your inventory decrease, the opposite will be true because you’re using up your inventory and that creates cash. Well, in that particular example, our inventory is going up by $10,000 so we need to subtract that.
  • Now, this exact same true is for accounts receivable. Our accounts receivable in this particular case increased by $15,000 which needs to be subtracted from cash. Now, had our accounts receivable gone down, we would’ve added that up to cash but we increased our receivables $15,000 and that ate $15,000 worth of cash.
  • Now with accounts payable again, it is the opposite. This is where it gets confusing about are we adding cash or are we reducing cash. So for accounts payable, if my payables go up, it’s creating cash because I’m borrowing money from you. If my receivables go down, I mean, if my payables go down, that means I’m using cash ’cause I’m paying you off faster. In our case, our payables went down so we’re decreasing our cash by $10,000.
  • Now, any capital equipment like vehicles or manufacturing equipment or computers, well, that’s all capital equipment. It doesn’t show up in your profit and loss statement but it sure does need cash. Why? You have to write that check out when you buy and go have equipment. So in our particular example, we spent $40,000 on a new truck.
  • And then finally, we subtract any repayments or loans that you’ve made. In our case here, we’re saying, what if I paid $20,000 in loans?

And once they add it all up, it will see what we have. We started out with $25,000 in cash from our last period, we’re adding a profit of $50,000, we’re adding $10,000 with depreciation, we’re adding $30,000 for money that we borrowed from the bank. And now we have to just subtract $10,000 for inventory increases, we have to subtract $15,000 for increased accounts payment, we have to subtract $10,000 for reducing your accounts payable, we have to subtract $40,000 for that new truck that we bought, and finally, we have to subtract $20,000 in the loans that we repaid. And this leaves us with an ending cash balance of $20,000.

Now, when we subtract the $20,000 from our beginning balance of $25,000, that gives us a negative cash flow of $55,000. So let’s think about this for a second. You made $50,000 in profit but you ate $5,000 worth of cash which is $55,000 difference on your profit and loss statement. Now, if you were going through the year thinking everything is ducky and wonderful and cheerful and you are making lots of money and everything was good, but if you do this for three or four or five years, that $25,000 worth of cash that you started your with will be disappearing. And eventually, you will be in the same position I was where your vendors and suppliers will be calling you saying, hey, where’s that money that you owe me? And you say, hey, I’m making all this money. How come I have no cash?

Well, if you don’t understand how to read your cash flow statement and you don’t put together a cash flow statement, you might find yourself in the same position I was in. So I want you to know how to put together a cash flow statement, and your next step is to spend some time with someone who can walk you through what’s happening to your cash in your business.

So why don’t you leave a comment below. Let me know what you plan to do about building a cash flow statement in your company and paying attention to that cash flow statement. Now while you’re at it, DOWNLOAD our FREE INFOGRAPHIC on the Stages of Cash Flow Freedom as you learn to crack the cash flow code. It’s free, it’s a one-page infographic, they’ll help you look at the five stages of creating cash flow freedom in your business. This is Josh Patrick. Thanks a lot for stopping by. I hope to see you back here really soon.

Topics: Video, profit, profit and loss statement, cash flow statement, cash flow, sustainable busines, cash flow from operations, accounts receivable, accounts payments, inventory, loans, new equipment, borrowed money, depreciation, cash

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