We’ve all heard the age-old expression: “Cash is king.” No other place is this more true than in business. Cash is the key component that makes any business function because it’s needed to pay banks, vendors, suppliers and employees. Having sufficient cash on hand may also help keep a company out of debt by removing a motive for taking out loans and by preventing unnecessary expenses such as late payment charges. In addition, when trying to determine how much a company is worth, one fundamental rule many investors use is to invest in stock that earns a lot of cash year in and year out. After all, a company is only worth what it can deliver in the form of cash to investors in the long run. Cash is needed for a company to grow and pay out shareholder dividends – both of which appeal to investors.
Statement of cash flows
Unfortunately, many businesses overlook the importance of cash flow analyses (cash flow budget, cash flow statement, etc.) because they believe that all of the essential financial information can be taken from the balance sheet and income statement. However, the Securities and Exchange Commission considers the information presented on a cash flow statement so important that it requires all publicly traded companies to have their cash flow statement, along with their balance sheet and income statement, audited each year.
A business owner may ask, “If there’s cash at the end of the day, why do I need to categorize the cash inflows and outflows?” The statement of cash flows is important because it helps to properly assess the incoming and outgoing flow of cash. It also gives insight into a company’s operating, investing and financing activities. By categorizing cash flow activity into these three categories, one can see if company operations are providing or using cash.
Operating activities must be the primary long-term cash source of a company. That is, operations must eventually pay for the company’s debts, dividends and growth. Otherwise, a business owner will have to continue making capital contributions or take out new loans to keep the company running.
If you have questions about your statement of cash flow or need assistance please feel free to call our office at 802.878.1963 or email [email protected]. Davis & Hodgdon Associates has been assisting entrepreneurs in the Burlington Vermont Metro area for more than 20 years.