<img height="1" width="1" style="display:none" src="https://www.facebook.com/tr?id=2402150793235450&amp;ev=PageView&amp;noscript=1">
214.751.3362 5601 Democracy Drive Suite 150, Plano TX 75024

What is Cash Flow: Why Is It Important?

Written By: MB Group

Cash is the most liquid asset any company has. That’s why the ability to produce cash is one of the most important factors that an investor looks at when assessing financial health and stability. Cash flow statements reveal how able a company is to pay its short-term expenses and show its viability as a long-term investment.

What Is Cash Flow?

In the most basic sense, cash flow seems simple. It is the amount of cash that flows in and out of a business. If that seems easy, it’s because it is. But many business owners don’t understand what items to include in cash flow calculations and may even confuse cash flow with other accounting terms. Accurately reporting cash flow is a fundamental yet often misunderstood part of business accounting.  

What Isn’t Cash Flow?

Cash flow does not account for any intangible monies that are expected in the future. Inventory bought on credit, accounts receivable, and depreciation are important for other principal statements but are not relevant to determining cash flow. Cash flow only includes amounts that have gone in or out as cash.

Many people think cash flow is the same as profit. And while they are both measures of a business’s success; it is important to know the difference. Profit is the amount of money left over from revenues after all costs have been paid. Profit includes credit entries, while cash flow represents only actual cash. Profit is a good indicator of a business’s ability to make money from goods and services, while cash flow gives a picture of the company’s ability to pay its expenses in the short-term.

Cash Flow Statement

There are three principal financial statements that every publicly listed business must provide to its shareholders: the balance sheet, the income statement, and the cash flow statement. These statements are published in quarterly and annual reports and should be audited by a third-party business accountant.

The cash flow statement reports cash activity from operations, investing, and financing:

  • Cash from operations includes the day-to-day cash amounts needed to perform the main activity of the business. Incoming cash sales and outgoing payments for bills are examples of cash from operations.
  • Cash from investing includes the cash associated with the buying and selling of assets. Property, equipment, and other long-term assets fall into this category.
  • Cash from investing includes cash paid or received from loan funds, debt offerings, and dividends paid to shareholders.

Why Is Cash Flow Important for a Business’s Survival?

Without adequate cash flow, a business needs to borrow more credit to stay in operation. When a company cannot afford their rent or lacks funds to payout dividends, they will not survive unless they can bring their cash flow back into the positive.  A large amount of debt is very difficult to recover from and a company with cash flow problems must reassess its strategy immediately.

The best way to avoid the consequences of inadequate or misreported cash flow is to partner with a reputable business accountant who can identify weaknesses and offer solutions to produce a healthy cash flow.


You May Also Like: 5 Reason to Hire an Accountant

Tags: Accounting

© 2022 All Rights Reserved The MB Group , LLC