How to read a cash flow statement

Of the three financial statements, the cash flow statement is the one owners look at least and need most. The P&L tells you whether the business model works. The balance sheet tells you what you own and owe. The cash flow statement tells you whether you'll still be operating in six months.

It exists because profit and cash are different things, and the gap between them is where businesses fail.

The three sections

Operating

Cash generated or consumed by running the business. Net income, adjusted for non-cash items like depreciation, then adjusted again for changes in working capital — receivables, payables, inventory.

This is the section that matters most. A healthy business generates cash from operations. If yours consistently doesn't while the P&L shows profit, something in working capital is absorbing it.

Investing

Money spent on or received from long-term assets — equipment, vehicles, acquisitions. Usually negative in a growing business, which is normal. It only becomes interesting when it's large relative to operating cash flow.

Financing

Money from or to lenders and owners — loan draws and repayments, capital in, distributions out.

The thing to look at first

Compare net income to operating cash flow.

If profit is consistently higher than cash from operations, your growth is being funded out of your own pocket.

A business showing $40,000 of monthly profit and $12,000 of operating cash flow is earning money it isn't collecting. Track that gap over six months. If it's widening, find out which working-capital line is causing it — nearly always receivables, sometimes inventory, occasionally a supplier who tightened terms.

Reading working capital changes

The signs are counter-intuitive the first time, which is why this section confuses people:

• Receivables up = cash down. You sold more and collected less.
• Receivables down = cash up. You collected faster than you billed.
• Payables up = cash up. You're holding onto money longer.
• Inventory up = cash down. Money converted into goods on a shelf.

This is why growth consumes cash. Every new customer adds a receivable before it adds a deposit, and the faster you grow, the wider the gap gets. Fast-growing businesses run out of money more often than slow ones.

A five-minute read

1. Is operating cash flow positive? If not, ask whether it's investment or a structural problem.
2. How does it compare to net income? A persistent gap is the story.
3. Which working capital line moved most? That's where your cash went.
4. Is financing propping up operations? Loan draws covering operating shortfalls is a countdown, not a strategy.
5. What's the net change, and does it match the bank? If it doesn't reconcile, stop and find out why before reading anything else.

Its one real limitation

The cash flow statement is historical. It tells you precisely what happened and nothing about what's coming — and the questions that keep owners awake are all forward-looking. Can I make payroll in March. Can I afford this hire. Should I take this contract.

For those you need a forecast, not a statement. But the statement is where the forecast gets its shape: the working-capital patterns visible in the last twelve months are the best available evidence for how the next thirteen weeks will behave.

Read the statement to understand the machine. Build the forecast to decide what to do with it.