Cash Flow Statements: Your Company’s early warning system

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Professional service firms need to provide their partners/shareholders with cash flow statements so they’ll be able to identify and address cash shortfalls and other problems. Continue reading this article to learn about the three main sections of a typical cash flow statement and why partners/shareholders should take action if statements indicate a possible liquidity issue.

Knowledge is critical to good decision-making. That’s why professional service firms should arm their partners/shareholders with the financial information that will enable them to identify and address cash shortfalls and other problems; before it’s too late.

Your company’s income statement and balance sheet contain most of the numbers you’ll find in a cash flow statement. But a cash flow statement also provides information about receipts and disbursements – information that’s essential to preventing liquidity problems.

A typical cash flow statement is divided into three sections:

  1. Operating activities. These numbers reflect your company’s operating activities and liquidity and can be used to identify revenue and earnings declines. If the amounts of your net income and operating activities are similar, your company is probably healthy. It’s also generally a positive sign to experience similar growth rates for net income and operating cash generated.
    But watch out when cash lags behind net income growth. Even if your company’s income statement shows that earnings are growing in double-digit percentages, flat cash collections should be scrutinized. Also keep an eye on growing accounts payable. An issue may exist if your company routinely delays payments to vendors because it lacks cash.
  2. Investing activities. The data in this section accounts for your company’s purchase and sale of property and equipment. Companies typically use cash to invest in technology and office machines. But investing activities may also cover lending by your company and subsequent collection, as well as the sales and purchases of long-term securities.
  3. Financing activities. The last section of your cash flow statement illustrates the company’s financing that isn’t used for daily operations. The largest cash outflow here is likely to be draws/distributions to partners/shareholders. But this section might also include loans from banks and other lenders, as well as capital contributions provided by partners/shareholders. If your company is growing quickly, consuming more cash than you generate may be appropriate. And if your company has substantial debt, repayment will affect cash available for draws/distributions.

Taking action
Your company may be focused on other profitable efforts, causing you to neglect cash flow. If you’re concerned about liquidity after reading your firm’s most recent cash flow statement, it’s time to take action.

Your partners/shareholders should discuss and document policies that will fix current shortfalls and prevent future cash flow problems. For example, you might decide to:
• Bill clients more regularly to minimize unbilled work in progress,
• Implement tighter accounts receivable controls,
• Pay bills on time, but not before their due date, and
• Time purchases to control variable expenses, avoiding major expenses during low cash flow periods.

If inadequate revenue is an issue, consider placing more clients on retainer and increasing existing clients’ retainers. Or you might raise your hourly rates. Raising rates in installments – say 5% in January and 5% again in July – can make higher rates easier for clients to swallow.

You should also monitor your company’s cash flow more carefully and frequently – perhaps on a weekly basis. And regularly compare actual cash flows with the budgeted amounts and work to reconcile any variance.

Avoid cash crunches
Cash flow statements serve as your company’s early warning system. To avoid an embarrassing and possibly crippling cash crunch, distribute these statements to partners/shareholders at least monthly.

What if you don’t have a cash flow statement or if your cash flow statement indicates that you may have a liquidity problem? Contact your professional advisor at Greenwalt CPAs, Inc. to discuss possible solutions and to put in place policies that will prevent future cash crises.

If you would like additional information or to discuss the topics mentioned, please contact Jim Wagoner, CPA at 317-260-4472 or jwagoner@greenwaltcpas.com or Brandon Cook, CPA at 317-260-4437 or bcook@greenwaltcpas.com