Money enters and exits your business through three doors: the door of day-to-day operations, the door of investments, and the door of financing. The cash flow statement shows how much came in and how much went out through each door. When you separate the three, you immediately understand why your account looks different from the profit on paper.
The first door is operations, that is, your daily work. Here, collections from customers come in and payments to suppliers, wages, rent, and obligations go out. This door shows whether the business itself is generating money or consuming it. It's the most important door, because in the long run only it keeps you alive.
The second door is investment. Money goes out here when you buy equipment, a work machine, or carry out a renovation, and it comes in when you sell an old piece of equipment. Expenditures through this door are often a good sign, because the business is building its future. But it has to be covered by the first door.
The third door is financing. This is where money comes in when you take out a loan or put up capital from your own pocket, and it goes out when you pay the loan installments or withdraw profit as the owner.
The sum of the three doors explains why your bill changed from the beginning to the end of the month. No mystery, just three charges added up.
This is the question that troubles most owners. The answer lies in three moves that profit doesn't see.
First, sales on open invoice. Profit recognizes it as revenue today, but the cash comes in two months.
Second, the goods in the warehouse. You've paid for them today, but they only become an expense when they're sold.
Third, the loan installment. The principal portion is not an expense on the income statement, but it is entirely charged off the account.
Therefore, profit and cash flow can go in opposite directions for months on end. Berman and Knight sum it up in Financial Intelligence with a line worth remembering: profit is an opinion, cash is a fact.
Take over a small wholesale trading company for a month.
The money at the beginning of the month was 500,000 LEK.
Operating income. Customer receivables: 900,000 LEK. Supplier payments: 600,000 LEK. Wages and contributions: 250,000 LEK. Operating cash flow plus 50,000 LEK.
Investment door. Purchase of an industrial refrigerator: 200,000 LEK. Cash outflow from investment minus 200,000 LEK.
Financing door. Loan installment: 100,000 LEK. Financing disbursement minus 100,000 LEK.
Money at the end of the month. 500,000 plus 50,000 minus 200,000 minus 100,000 equals 250,000 LEK.
Meanwhile, the income statement for this same month shows a profit of 150,000 LEK, because it counts billed sales rather than cash receipts, and neither the refrigerator nor the loan principal are expenses of the month. Profit of 150,000 LEK and an account receivable of 250,000 LEK in the same month—both accurate.
At the Resource Center you'll find a simple monthly flow chart with three separate doors and automatic aggregation. Ten minutes at the end of the month give you the full picture. You'll find it at the Resource Center. Resource Center.
The cash flow statement is prepared using the direct method—classifying cash receipts and payments by nature—or the indirect method, in which the profit or loss is adjusted for non-cash items and for changes in working capital. The presentation requirements and the method to be used are specified in the relevant Accounting Standards.
For consulting work with small businesses, the direct method is almost always more valuable, because it speaks the owner's language: I collected and I paid. A quick indirect control bridge is the formula: earnings plus depreciation, minus the increase in receivables, minus the increase in inventory, plus the increase in payables. If this bridge doesn't tie to the bank's movement, the difference pinpoints exactly the unrecorded item.
The account tells you how much you have, not why you have it. Without separating the three doors, you can't tell whether the decline comes from poor performance or a good investment. Separation is what gives you peace of mind.
It's a sign to be taken seriously, but calmly. It happens during a weak season or rapid growth. If it continues beyond the season, you need to review the billing cycle and inventory levels with an economist.
If you want a clear view of all three of your streams every month without having to deal with spreadsheets yourself, check out our packages at offer.
We take care of accounting and taxes, so you can save time, money, and focus on growing your business.
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