Why Creating a Cash Flow Statement is Critical to Your Business

When small business owners connect with Northwest Bank to ask about business loans and other commercial products, Myles Bremke wants to see one document in particular — their cash flow statement. “This shows how much money is circulating through the organization,” says Bremke, Northwest Bank’s regional senior vice president for small business.

The cash flow statement helps lenders understand your potential for profitability and, more importantly, how much liquidity your business has to pay its expenses. “Your cash flow shows your ability to make monthly loan payments,” Bremke says. It also highlights areas for improvement — a cash flow statement might reveal the need to tighten up your receivables terms or negotiate with your vendors for longer payment cycles.

For these reasons, creating a cash flow statement — even if you’re just beginning your small business journey — is a smart idea. By understanding the different types of cash flow statements, how to create one, and why they’re beneficial, your small business will be on a faster track to more liquidity and success.

Types of cash flow statements

There are two types of cash flow statements that small business owners should be familiar with: direct and indirect. The direct cash flow statement reflects cash in and out of your business in real time. If you paid a supplier, then that money has left the business. And if you received payment from a customer, that cash is now available to the business. “It gives you data points that show you exactly where your cash is going in a clean way,” Bremke says.

The direct method provides transparency into your business finances, showing cash inflows and outflows as they happen. However, it doesn’t account for revenue you’ve earned but not yet received. That’s where indirect cash flow statements come into play. Indirect cash flow statements start with your company’s net income and then reflect changes in assets and liabilities over the accounting period. For instance, if you sold a product, you’d likely recognize the revenue sale in the month you made the sale, even if the customer still hasn’t paid you.

Bremke says that most small businesses begin with the direct method because they can pull familiar numbers off their balance sheet. However, business owners often move toward the indirect method to get a more comprehensive view of their finances. “There are more data points on your indirect cash statement,” Bremke says. An accountant typically puts together an indirect statement because they are more complicated.

Why cash matters

Understanding your cash position can help you access the capital you need to grow your business. But it also provides many other benefits. For instance, a cash flow statement can provide an analysis of your expenses, showing you potential areas to cut back. The statement can help improve your short-term planning and control spending to remain solvent, even in tough times.

Bremke notes that cash flow statements are also particularly useful when people are looking to acquire a business. “You want to know when you get those keys and turn on the lights, how much cash you need to keep that business running,” he says. People often don’t anticipate that they’ll need to inject a new business with cash to fund operations in the first few months after they buy it. The same goes for providing information to potential buyers if you plan to sell your company someday.

The secret sauce

When banks review a business for a loan, they consider what Bremke calls the three Cs: collateral, credit and cash. The first — collateral — is your existing assets. Credit refers to your credit history and score, which will inform the terms of your loan. And cash, of course, is your cash flow statement. However, each bank approaches cash flow in its own way. “It’s kind of their secret sauce,” Bremke says. “Every bank has its own parameters.”

For example, some banks may discount items like revenue projections. Others may consider a business owner’s personal income. “The bottom line is that the bank’s view of your cash flow may be different than what you see,” he says. With that in mind, it’s important to connect with your business banking partner early and ask them what’s important to them regarding your cash flow statement.

Business owners know that cash is king. Wrangle your cash flow with a cash flow statement, and you’ll get an in-depth look at where your cash is going and how much you have to help your company grow.

If you want to learn more about cash flow statements, connect with one of our small business bankers today.