Understanding cash flow statements

Cash flow forecasts and analysis

Most business owners understand that cash flow is essential for their business. Perfectly viable and even successful businesses can fail due to poor cash flow so understanding how it works on a practical level and the signs of cash flow problems in the future are as important as having the right product, service and staff.

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Cash flow analysis, reports and forecasts are essential tools for a growing business to plan ahead, spot trends or risks and to be ahead of the game.

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Cash flow statements

Once you have calculated EBITDA, the cash flow statement is where you make adjustments for items that don’t appear in the Profit and Loss Statement, but that consume or release cash.

These are typically: Interest paid, Tax paid, Changes in Working Capital, Capital Expenditure, Loan repayments and Dividends.

So if you have successfully calculated EBITDA, the first thing to do is to deduct interest and tax.There are three parts to working capital :-

• trade debtors (how much the company is owed – which will hopefully turn into cash),
• trade creditors (how much the company owes to others - which is just like short term debt): and
• stock (which is also a bit like cash in terms of its value to the business).

These figures are all in the accounting notes and need to be treated individually.

Working Capital

Changing levels of working capital can really threaten (or improve) the health of a business. It's perfectly possible that a profitable business can be consuming cash if the trade debtor figure is increasing (sometimes known as “Growing Broke”), and equally possible for a loss making business to be generating cash by shrinking inventories, chasing trade debtors and not paying its bills punctually.

Once the net effect of working capital is dealt with, the next thing to do is to try to isolate the value of the Capital Expenditure (which is the amount of cash spent purchasing fixed assets for the business). This is the real world equivalent of depreciation.

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