When I discuss a set of financial statements with a business owner, an often uttered lament is “I have made this profit but where’s the cash gone?”. In days of your, it was a requirement that a set of financial statements would include a cash flow statement as an essential element of the package.

Unfortunately, this very valuable statement ceased to be mandatory for smaller companies.

In my view, its value for the largest companies has also been compromised by the mandatory format which is significantly unintelligible with a predilection for esoteric terminology.

For the business owner who does not have a sophisticated financial background, the key note should be simplicity.

After all, we are preparing a cash flow statement, not a source and application of fund statement.  It needs to do what it says on the tin:

  1. What cash has the company generated
  2. What has it spent the cash on
  3. What cash has it retained

I reckon that we should all be able to understand that.  A few areas might need to be explained in more detail:

  • The adjustment to profit to establish cash generated from operations needs to include items such as depreciation and amortisation, where this deduction is a paper one and has not involved a payment.
  • Cash outflows will include dividends as they are a post-tax reward.
  • How the movement on the director’s loan account has been dealt with will need consideration.
  • The retention or release of funds from the business through working capital movements (i.e. stock, creditors and debtors) should be explained. Broadly, if you have more stock, you have spent more cash.  If debtors has increased, then that is cash which is not in your account.  If you have paid creditors more quickly, then that is an outflow of your cash. The information needs to be kept simple.

Indeed, working capital is where the useful conversation really takes place to explain the impact of cash on stock levels, debt collection, performance and creditor payment performance.

The profit and loss account can always be subject to some skilful presentation but the cash flow statement is the acid test. A cash flow statement can often detect insufficient cash generation, excess reward extraction or inefficient working capital management, sometimes more than one.

If the cash runs out, that means trouble.

Posted by Paul Short

The views expressed in this article are the personal views of the Author and other professionals may express different views. They may not be the views of Lambert Chapman LLP. The material in the article cannot and should not be considered as exhaustive. Professional advice should be sought in connection with any of the issues contained in the article and the implementation of any actions.

Lambert Chapman Chartered Accountants

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