The importance of a cash flow statement
In some articles of our series regarding management we have referred to and discussed various aspects of a cash flow statement. In this article we will discuss the importance of a cash flow statement in more detail.
The recent drought has brought to the fore that it is absolute important as part of financial management that we pay attention to the cash flow statement. These days cash flow is probably the most important aspect of financial management of a farming business.
Financial management consists of four main activities of which the first one is financial record-keeping and compiling of the necessary financial statements. The purpose of the financial statements being to determine the financial result (profit/loss) through an income statement, to determine the financial position (ratio of assets related to liabilities) through a balance sheet and to determine the cash flow position via a cash flow statement. The information from the statements then provides one with a picture of the success of your business. Your business is only 100% successful if the results from all three statements are positive.
A danger of the process when compiling financial statements is that it is possible for someone who understands the process quite well to adjust the figures in the statements, especially in the balance sheet and to a lesser degree in the income statement, to suit a specific purpose. This can be done for tax purposes or when one is in need of a loan. However, because an actual cash-flow statement reflects the inflow and outflow of cash in the business one cannot adjust the information to suit a specific purpose. Your actual cash flow statement has to balance with your bank statement of the same date. A bank statement is an external source of financial information. This represents the first importance of an actual cash flow statement – it provides accurate financial information regarding the cash flow of a business.
Secondly, your cash flow statement will be the first statement to signal whether something is wrong in your business or not. For a normal general mixed type of farming, as a rule of thumb, the cash flow ratio should be 120% or better. The ratio is calculated by expressing cash-income/cash-outflow as a percentage. This aspect will of course only be true if your cash flow statement is up to date and preferably on a daily basis. With the technology of today this is quite possible to achieve.
Thirdly, practically this statement indicates whether you will have enough cash available at any specific time, such as at the end of a month, to meet all your commitments. For instance, the paying of wages, electricity bill, monthly payments on accounts, and so forth. Should you not be able to meet all your commitments at any given time, it will be the first sign of a problem in your business, except if you can explain the position satisfactorily. You may have incurred a lot of production expenses (outflow) before an inflow of cash from a crop to be harvested.
Fourthly, another important aspect of a cash flow statement is to judge the debt servicing ability of your business. This is normally judged by using the information as portrayed in a projected cash flow statement. As of late this is a very important issue and when applying for credit the financier will have a thorough look at your projected cash flow statement. The financier will also calculate the projected cash flow ratio using the information from your projected cash flow statement. As already explained it is regarded that this ratio should be 120% and higher indicating that you should have enough cash available to pay all debt and all other farming expenses as required.
Apart from what is discussed as important regarding a cash flow statement the real value of this statement is experienced when proper financial management regarding this statement is applied. This will entail that before the beginning of your financial year you should compile a projected cash flow statement which should then be compared to your actual statement on at least a monthly basis.
By doing this you take control over your expenses and should there then be an overspending it must be explained and if necessary you could adapt the cash flow statement accordingly. Expenditures (cash-outflow) are normally under your control.
Income (cash-inflow) is normally influenced by various macro factors over which a farmer has very little influence, if indeed any. Should your income be lower than projected, you should adapt your cash flow statement to accommodate the lower income. In practical terms a lower income implies that you have less money to spend. Therefore, you will have to consider expenditures thoroughly and if need be, postpone certain expenses. A lower income could also force you to apply for additional credit to keep your business running.
To conclude, to survive under the present challenging circumstances of a farming business in South Africa, it is of the utmost importance to become financially literate.
Article submitted by Marius Greyling, Pula Imvula contributor. For more information, send an email to firstname.lastname@example.org.
Publication: April 2017