Is your accountant asleep? Wake him up! Part 3

Many accountants tell you they provide value, that they do a good job for you. But when was the last time you received a Cash Flow statement from them? Do you even know why it's so crucial for you?

The truth is, profit is only part of your company's financial picture. Let me tell you a story that sheds light on why this is the case. Imagine a company that looks thriving on paper – it generated an after-tax profit of £50,000. Shareholders are naturally delighted, thinking it's an excellent time to pay out dividends. But this is where the problem begins. Even though the profit is impressive, the company is struggling with a lack of cash. A lack of funds means it can neither invest in growth nor even cover current needs – from employee salaries to purchasing new equipment. The shareholders' expectations quickly turn out to be a pipe dream.

Why do I need Cash Flow?

This is where Cash Flow comes in, a statement of cash flows that shows not only profits but, more importantly, how money moves through the company. It reveals whether the business has enough cash to meet its obligations. In our company's case, the Cash Flow statement could reveal that despite seemingly good profit, the reality is far from expectations.

So why is Cash Flow so important? Because without it, even the most profitable company on paper can find itself in trouble when it comes to financial liquidity. Expenses, such as tax payments or dividends, require real money, not just figures on paper. And what if the company suddenly needs to increase production or invest in new technologies? Without access to cash, all these actions become impossible to implement.

How to calculate a statement of cash flows?

Let's assume the company has the following financial parameters for a given month:

Cash Flow = Revenue − (Fixed Costs + Variable Costs + Planned Investments + Planned Dividend)

Cash Flow = £135,000 − (£30,000 + £20,000 + £25,000 + £10,000) = £50,000

In this example, the company's Cash Flow for the given month is £50,000. This means that after accounting for all expenses, the company has a surplus of £50,000, which it can allocate to further development, emergency funds, or other business objectives.

This example shows how crucial it is to monitor Cash Flow to ensure that the company not only generates profit but also maintains the ability to cover current and planned expenses, which is essential for its financial stability and growth potential.

When should you start to worry?

The company, by not calculating Cash Flow, believed that after covering operating costs and investments, they would have a surplus profit that could be paid out to shareholders as dividends. However, they did not take into account that costs and investments could significantly strain their financial liquidity.

Let's calculate the company's actual Cash Flow to see where the problems arose:

Cash Flow = Revenue − (Fixed Costs / Variable Costs + Planned Investments + Planned Dividend)

Cash Flow = £1,000,000 − (£600,000 + £400,000 + £50,000) = -£50,000

In this example, the company's Cash Flow is -£50,000, which means the company actually generated a negative cash flow. Although on paper it seemed the company was in good financial health, not taking Cash Flow into account led to a situation where actual expenses exceeded available funds.

Negative Cash Flow means the company did not have enough cash to cover all its obligations, which could lead to liquidity problems, the need to incur debt, or payment delays. This shows how important it is to regularly monitor Cash Flow to avoid such financial pitfalls and ensure the company's stability and ability to grow.

Accounting in Business

Therefore, in today's world, both entrepreneurs and accountants must not only focus on profits but also on optimizing cash flow. Cash flow is the lifeblood of business, allowing it not only to survive but also to thrive in the unpredictable world of finance.

What about you? Does your business have enough cash to do more than just exist?