Why is it that so many profitable companies have little or no cash in their accounts while other unprofitable companies can have lots of cash? This drives business owners crazy and leads many to suspect that Financial Statements do not properly reflect the company’s circumstances.

There are two primary financial statements for any business – the Balance Sheet which measures assets and liabilities between periods (typically monthly); and the Income Statement or Profit and Loss Statement, which measures a company’s operating performance.

Cash flow is measured as a result of an interaction between the two statements and can oftentimes be a source of confusion for business owners. For this reason, most accountants prepare a third statement called, Statement of Cash Flows that ties the Balance Sheet and Income Statement together and reconciles beginning cash with ending cash in the company bank accounts for a specific period of time.

A Statement of Cash Flows typically consists of three categories.

• Cash Flow from Operations
• Cash Flow from Investing Activities
• Cash Flow from Financing Activities

Cash Flow from Operations considers only the “cash received” from sales and “cash paid-out” for expenses relating to sales. Therefore, net income or profit is adjusted for any “non-cash” items like depreciation. (Depreciation is a tax provision that enables companies to rebuild cash to update or replace fixed assets needed to make future sales.) Cash Flow from Operations also considers the difference between selected balance sheet items at the beginning of the period versus those balances at the end of the period.

For example, a reduction between Beginning Accounts Receivable and Ending Accounts Receivable is termed “cash collections” and/or “write-offs” for sales that will never be collected. This same procedure is used to compare beginning versus ending accounts like Accounts Payable, Inventory, Pre-paid Expenses, Accrued and Deferred Expenses like salaries and taxes. These items may be shown as expenses on the Income Statement but will be paid at a later date. The end result is a calculation that totals all of these account balance differences to determine if net cash was “generated” from operations (collections exceeded cash expenses) or “used” by operations (cash expenses exceeded cash collections) for the period.

Cash Flow from Investing Activities considers changes in Fixed Asset balances like trucks, machinery and equipment, etc. In other words, did the company spend money to buy new assets or bring in money from selling off old assets?

Cash Flow from Financing Activities considers any new borrowings or loan reductions made during the period as well as cash distributions to stockholders.

Finally, the “net cash” generated or used for each category is summed and that “cash” amount is added to the cash balance at the beginning of the period. The resulting number will tie into the company’s actual cash balance on the last day of the period.