Understanding Cash Flow Impacts Your Business Success


Your business’ cash flow statement is one of the most important financial documents you utilize as a business owner. Cash flow statements report the cash generated (income) and used (expenses) during a given time period, and categorizes those expenses as operating expenses, investing activities, and financing activities. Because it is a true indicator of a business’ cash inflow and outflow, your cash flow statement provides the best gauge of whether your business is financially healthy or headed for trouble. Either way, knowing is much better than not knowing, and with a timely cash flow statement in hand, a business owner can make the decisions required to course correct when necessary.

“Financial reports are the GPS for your business. The successful business owners I have dealt with are ones who stay on top of their numbers”, says Magnusson Balfour Business Broker, Ed Larochelle. “A strong business owner is going to have financial goals for the year, some parameters for expenses, and be conducting regular reviews of their cash flow statement. How can you know how your business is doing unless you have timely financial information that you actually look at?!”

Successful businesses:

  • Set annual financial goals;
  • Stay on top of business cash flow with timely reports;
  • React quickly to financial changes; and
  • Understand the difference between cash flow and taxable income.

From a business broker’s point of view, a business’ cash flow statement plays a critical role in business valuation. It’s a warning sign when a business owner is asked for the financial information, and their response is to hand over three years of tax returns in unopened envelopes from their accountant, and they’ve never asked to receive interim cash flow statements that they review. This scenario is an example of a business that is running the owner, not an owner running their business. When your business is running you, all you can do is hope for the best and react. When you are running your business, you can plan. In order to have planned responses to financial changes – to be able to recalculate, reposition, track your margins, and know your expenses are not out of hand – you must get timely financial reports and review them carefully.

Not every business owner understands the importance of staying on track and having clear financial goals. Having all your bills paid up and a balance in your bank account is not staying on top of your business’ financial health. An owner who knows their numbers is always more successful than the owner who is just going through the motions, reacting when needed. That owner is not really in charge. It’s like riding a toboggan down a hill and hoping you don’t run into a rock, versus getting in a car and steering yourself where you want to go and around the rocks!

A successful business owner can say at any given time, “I have a goal of increasing my business 10% a year in both gross revenue and cash flow, here are my monthly reports of where we are, and here are the adjustments I have made to keep us on track to meet our goals.”

Set measurable annual goals.

Having clear, annual goals are the foundation of business success. Before the start of a new year, it makes sense to look at last year to see how your business has been doing. Look at areas that need improvement, what expenses can be reduced. Maybe the business is growing and will need the added expense of additional staff or new equipment. A goal might be paying yourself more (“I want to make a six-figure income”), so what do you need to do to get there? What do you want to do revenue-wise, what do you want to do income-wise, is expansion desired? Are there major investments in the business necessary? You can’t pick numbers out of the air, so you need timely financial reports to show you where your money went over the last year.

Throughout the year, preferably monthly but certainly quarterly, carefully review the financials via the cash flow statement, and compare them to the goals that are set and make course corrections as necessary. This makes things so much easier – you may not be on target, but you will eliminate more costly expenses from burying your head in the sand!

Monthly financial reports save time and money.

People get overwhelmed with financial management, leaving everything to someone else because they don’t like dealing with it, or perhaps they don’t really understand it so it’s human nature to avoid these things. However, if we break it down, business financials are a lot simpler than they may look at the outset. A simple spreadsheet detailing income and expenses can go a long way to organizing money in and money going out, and software programs like QuickBooks are affordable and handy because you just need to plug your numbers in and the reports auto-generate for you at the touch of a button.

Having the information delivered to you by some mechanism on a month to month basis, gives you what you need to know as a business owner, and will keep the business on track and alert the need to make changes before things get worse. When you know up to the minute (or as timely as you post information) how your business is doing, compared to your goals, you can figure out where you are doing well or going in the wrong direction. When revenue and expenses can be monitored easily, and you know what your budget is and where it stands currently, the power is in your hands and you are running your business proactively. Perhaps you need to raise your prices, look for better supplier agreements, or maybe there is money to purchase new equipment now and start making money with it in this fiscal year. Cash flow statements show you in detail the performance of your business so you can run it effectively.

Tax returns are misleading.

Tax returns have a totally different purpose in the financial picture of a business. Tax returns don’t tell you what the business is actually doing on a weekly/monthly basis, nor do they provide an accurate picture of a business’ performance. The level of financial detail doesn’t show the impact of individual expenses, or how they relate to the budget. Because we are always looking for ways to reduce our taxable income in a business, adjustments such as depreciation, non-cash paper transactions, and perks and benefits to owners are used to reduce taxable income and consequently the tax burden. As you can see, these adjustments skew the picture of actual cash flow.

Cash flow is not income.

There is a distinct difference between income and cash flow. Income (taxable income) has been adjusted to reflect the benefits and compensation to owner, depreciation, interest expenses, perks in lieu of compensation, and non-recurring expenses. Debt service impacts the cash flow statement in two different ways: the interest shows as an expense, but the principle repayment amount is not considered an actual expense on a financial statement; however, it is considered when evaluating the actual cash flow requirements for the business when considering profitability and value. Cash flow is determined after all these adjustments have been made, hence showing the real performance and cash flow requirements of the business. Clearly understanding the difference between income and cash flow is of great benefit to owners and financial management, another reason that a tax return is not the best report to use.

When a business broker is determining the value of a business, it is critical to be using accurate cash flow rather than looking only at the tax returns or business income. The only way to really know how a business is performing and what it is worth, is to use an accurate cash flow statement where those adjustments have not been made to the bottom line. That is how we compare your business accurately to other businesses as well, a key component in determining valuation.

The only way to figure out what’s what is to stop and get your numbers in front of you. It’s the only way to gain some control over the future of the business. You either react and become a victim of the numbers, or with preparation and planning you minimize financial surprises. Which sounds better?

Run your business – don’t let your business run you!

Special thanks to Magnusson Balfour Broker Ed Larochelle for his valuable input into this article!