Understanding What Cash Flow Is

Before proceeding, let’s review what cash flow is. Plain and simple, it is the amount of money leftover from what is coming into a business (think accounts receivable and customers paying their invoices in a timely manner) and what is going out of a business (accounts payable, think paying utilities bills, and purchasing inventory).



A positive cash flow gives businesses the ability to pay their debts. When a company takes out a business loan to purchase inventory or equipment, it needs to have enough future cash flow to make those monthly loan payments. A healthy cash flow also affords the ability to invest in the growth of a business.

A cash flow statement allows for:

• Insight into how actual cash is spent
• Planning for the short-term and long-term
• Focus on activities that can increase future cash-flow
• Better understanding of the actual costs of doing business
• Analysis of working capital
• Crisis management in the event of a future cash crunch

Businesses that cannot provide a positive cash flow statement could have issues under the hood, such as problems with suppliers or vendors who are unwilling to work with them to provide goods, supplies, or services. This could mean an uphill climb to rebuild business goodwill, which will affect someone who is considering buying the business, especially if the damage is already done and has trickled down to its customers.

Why Can’t an Income Statement Be Trusted Completely?

It is great when a business can show that it is profitable. However, a profit and loss statement (also known as an income statement) cannot adequately represent its financial standing. A business can be profitable on paper, yet at the same time have negative cash flow and unable to purchase inventory or supplies. The business may not be able to pay its operating expenses like its electric bill or rent, and these unpaid expenses are unlikely to show up on an income statement.

Once a business is unable to replenish its inventory, sales are going to suffer. It may take a little time, but eventually it will catch up to them. It is easy and perfectly legal according to generally accepted accounting principles (GAAP) to manipulate an income statement. GAAP allows businesses to use depreciation and amortization, both non-cash expenses, to offset capital expenditures. 

An income statement represents sales income, but not the actual revenue received from those recorded sales. It fails to consider the existence of credit sales that could take 60 to 120 days for payments to hit account receivables. Meanwhile, if the business’s cash on hand is inadequate, there may not be enough money to cover operational costs until those payments come in. Having enough cash flow, realistically at least three months’ worth of operating expenses, is critical to covering the realistic cash gap that exists between AR and AP.

Lenders Look for Cash Flow

Cash flow matters to lenders. If you are seeking funding to help finance the purchase of an existing business, lenders are going to look at much more than your business plan. They will look at the big picture and yes, if you are purchasing a business with existing cash flow problems, you may need to make a substantial investment to set the ship right and get it back on course with a positive and stable cash flow.

Cash flow statements are important business tools that you can learn a lot from in regard to buying a business or running your own in the future. They allow you to project actual real profit and help you prepare for times when you may need more cash or credit to keep operations going.

For assistance and guidance in buying a business or preparing your business for sale, contact the experts at OConnor Business Brokers and Consultants today.