How To Prepare A Cash Flow Statement Step By Step King Cash, Queen Cash Flow, and Prince Profit

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King Cash, Queen Cash Flow, and Prince Profit

Running a business requires cash on hand. Cash enables bill payments, salary payments and capital improvements to fuel expansion. Cash, however, depletes quickly and must be replenished with steady cash flows for a business to survive, even in the most prosperous times. In the new economy, poor cash flow is killing businesses.

Cash vs. cash flow vs. profit:

The common experience of preparing to wash your face provides a simple analogy for these complicated and intertwined financial metrics. Both the connection and the drain represent a cash flow that can further be defined as inflow (inflow) and outflow (drain). The water flowing down the sink is analogous to the income flowing into the company. For cash flow, it doesn’t matter if the product/service is sold at a profit or a loss, as long as the revenue flows. In contrast, all of the company’s costs are represented, from electricity bills to insurance to payroll to supplier costs along the drain. Just as water drains from a sink, money drains from a company. Water accumulating in the sink represents cash in hand. Finally, increases (profit) or decreases (loss) in the amount of water in the sink, from one measurable time to another, represent the company’s profit.

So, for example, a company may measure profitability monthly, quarterly, and/or annually, which means it compares revenue inflows minus expense outflows to determine which was greater over a period. If the inflows were higher, the company was profitable. If outflows were higher, the company operated at a loss.

Any measure of financial achievement is essential. Moreover, increasing each measurement is critical to business continuity and growth.

King Cash:

King Cash rules the kingdom. The bigger your company’s cash pile, the better you can sleep at night. Although saving doesn’t solve problems, it does give you something otherwise unattainable: time. If the company is operating in the red (unprofitable) or cash outflows are greater than inflows (negative cash flow), cash on hand buys you desperately needed time to correct these problems. Both will need to be corrected in order to survive; cash gives you time to figure out how to turn it around. Ironically, by definition, the money your company has now came from positive cash flows and profitability at some earlier point in the company’s history. It was collected annually in the Retained Earnings line item of your Balance Sheet and deposited into your savings account.

With no real cash on hand, the company has to turn to debt in tough times. Unfortunately, banks and lenders are slow to lend cash to struggling companies. So if your company is in crisis and you didn’t execute a financial disaster preparedness plan when times were better; there is little you can do except liquidate the assets. If, on the other hand, all three indicators are on the rise, now is the time to apply for or take out a company line of credit. This is best done with a recently signed major contract in hand and the latest financial statements neatly printed and expertly bound.

The queen of cash flow:

King Cash rules the kingdom as head of state; but, Queen Cash Flow is his neck. And everyone knows that the neck turns the head. So, assuming your company isn’t cash-rich, the metric that rises above the rest to look at is cash flow.

Imagine a situation where a company is profitable on paper, meaning it sells its goods/services for more than the delivery cost; but the money is not flowing. This would mean that income is due as receivables; it still hasn’t arrived at the company’s door. How long can the company survive? Assuming the company has no cash and no way to get a quick, temporary infusion of cash (a line of credit), the question can be answered another way: how long will you and your co-workers continue to work for the company after the payday has come and gone without payments? Suffice it to say that the demise of a company is measured in weeks, not months or years.

Prince Profit:

Companies operate to make a profit – period. Without profit, there is no growth, and the value of a company declines as assets age and lose value. Profit, like a crowned prince, must be treated with respect in order to prepare for the future. Profit can be ignored in difficult situations to satisfy King Cash and Queen Cash Flow. However, if this happens for more than a short time, the company’s future is at risk.

A financial metric is a company’s royalty. Everyone must be cared for and cared for. As cash flows increase, cash on hand and profits also increase over time. Although economic times are dire, the rules of corporate finance never change. As complicated as these topics may seem, they can be boiled down to a very simple principle that you probably learned growing up – “if mommy ain’t happy, ain’t nobody happy.” Take care of your cash flow and that positive cash flow will take care of everything else.

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