When you became a small business owner, you were likely well aware of the statistics: the majority of small businesses fail within the first five years. What’s lesser known is why. According to a recent study by the U.S. Bank, it all boils down to cash flow. At the time of the study, 82% of these businesses failed due to poor cash flow management or a poor understanding of cash flow.
For many small business owners, financial statements can be intimidating and they are always time consuming. But having a good understanding of your business financial statements is an extremely helpful way to better manage your operations and plan for growth. It helps you avoid making rash decisions and protects your business’ long-term financial health.
The Importance of Your Cash Flow Statement
So, you would like to understand your business finances better? Look no further than cash flow analysis. A cash flow statement gives you great insights into how much cash your business generated or used during a specific accounting period. It shows you how cash and cash equivalents are moving through your business.
In short, cash flow analysis compares cash received with cash paid out. This data can help you identify which business activities are working and how accurate your forecasting was. You can also determine whether your business has sufficient cash flow to maintain operations as things are, or if you need to seek out additional funds.
The Direct Method vs. the Indirect Method
It’s important to note that there are two different ways to calculate operating cash flow: the direct method and the indirect method. Regardless of the one you decide to use, you’ll need up-to-date, organized bookkeeping with good data.
The direct method is used by companies that follow cash basis accounting. With this method, cash inflows and cash outflows are the only items measured. The indirect method, on the other hand, is used by businesses that utilize accrual basis accounting; this method includes both cash and non-cash transactions.
A Quick Cash Flow Statement Breakdown
Generally, there are four main components to a cash flow statement: cash flow from operating activities, cash flow from financing activities, cash flow from investing activities and net change in cash balance. It’s important to understand what makes up each of these categories (e.g. financing activities include notes payable, lines of credit, long-term debt, and short-term debt).
The numbers that make up each of these sections is what allows you to see whether you’ve had positive or negative cash flows over a given period of time. If you’re meeting with a lender, they will also use this information to quickly assess the liquidity (or cash on hand) of your business to determine what your business may be able to handle.
How to Optimize Your Cash Flow
If analyzing your cash flow statement and making changes to day-to-day operations isn’t enough to boost negative cash flow, it might be time to seek additional working capital. Alternative business funding is a great way to improve cash flow quickly, with some lenders providing capital in as little as 24 hours.
The key to a successful business long-term is to understand your cash flow situation at all times, identify when your business needs additional funding the most, and know where to turn to get it. It’s always best to reach out to a provider that specializes in working with business types like yours before you are in desperate need of cash to keep things running smoothly.
Michael Hollis is a Detroit native who has helped hundreds of business owners with their business funding solutions. He’s experimented with various occupations: computer programming, dog-training, accounting… But his favorite is the one he’s now doing — providing business funding for hard-working business owners across the country.