Virtually every CEO or business owner knows how to read their company’s income statement – Revenue, then Gross Profit, then Operating Profit, then Net Profit. Many only look at the top and bottom numbers, some delve deeply into the details in between. But they all know that the bottom line doesn’t ever translate dollar-for-dollar into an identical change in their bank account, unless they’re the corner ice cream store that only takes cash (are there any of those even left on the planet?)
And yet there is a clear relationship between your net income and the net change in your cash balance. That relationship is described clearly on a routine report that every accounting system produces, but that most CEOs and business owners never look at. Its name, strangely enough, is the Statement of Cash Flow. OK, maybe that sounds a bit smart ass, but it has puzzled me for decades why this is still true in most of the small and middle market companies we see that don’t have a competent and communicative CFO or Controller. Or an aware and inquisitive board of directors or advisory board. If the ever-changing relationship between net income and net cash flow isn’t apparent by reviewing the company’s monthly reports, then the CEO’s choices are to:
- ask for an analysis of the causes,
- guess at the causes, or
- review a statement of cash flow, which sets out those causes in a clear and standard format.
Full disclosure: this report is admittedly not as simple to read as an income statement or a balance sheet. But that’s no reason to ignore the immense amount of valuable information it contains. At first some of the ins and outs of cash generation will give pause – how did the write-off of previously paid insurance or property taxes produce cash? But it doesn’t take long to get the relationships clear if you’re serious about it. And if you trend it over 6 or 12 months, Wow! Years ago we were engaged by a small aerospace firm run by brothers who didn’t even have a working cost accounting system in place when we met. But within a few months the brother who was not responsible for the front office was able to explain the cash flow statement to me instead of the other way around. And he didn’t even have the advantage of the excellent explanation outlined in Chapter 6 of my book.
If you’re running a company or any organization that is designed to produce a profit – or more likely, a positive cash flow – make this report an addition to your monthly financial package, and review it in at least the depth you devote to your other reports. If you do, you will soon appreciate its power to inform and guide management decisions. And you too will be puzzled that every CEO doesn’t get it.
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