"SHOW ME THE MONEY!", the CASH FLOW STATEMENT (EP09) - a podcast by David Darab, DDS, MS, MBA

In this Podcast we continue our deconstruction, decoding and deciphering of the key financial statements. Last episode we dug into the Income Statement. I hope you found that insightful. If you haven’t heard it yet no worries, check it out when we finish here! This Episode is about the STATEMENT OF CASH FLOWS. The third and final Financial Report you should be reviewing monthly.

To begin, let’s make sure your accountant is providing this report to you. I have found that the CASH FLOW STATEMENT is not always included in the monthly reports, but can be added simply by requesting it. And as you will learn here, this is an important report to review! In fact, it could be the most important report, since CASH is least subject to estimates and assumptions and critical to keep your business afloat.

In each of the three financial statements we have studied, there is a measure, or indicator, of business performance;

In the Balance Sheet we have Owner’s Equity, or Retained Earnings.

In the Income Statement we have Net Profit,

And in the Statement of Cash Flow we have Operating Cash!

Remember Profit is NOT Cash!

Profit is a PROMISE, and contains estimates, assumptions, and adjustments, not MONEY coming in! You need Cold Hard Cash to pay yourself and your employees, buy supplies along with investing in equipment!

CASH is a Reality Check! PROFIT is VANITY!

So you might be saying to yourself, “Who cares anyway, who watches CASH?” Well…Only the most successful investor of all time….WARREN #BUFFETT!!

Warren Buffett , along with his business partner, Charlie Munger, know all too well that the INCOME STATEMENT and BALANCE SHEET can contain all sorts of estimates, assumptions and biases that can distort their information.

CASH is different. With CASH you are indirectly examining the Bank Account of the Firm. CASH is the number least affected and influenced by the Art of Finance. CASH is a reality check.

PROFITS do not equal CASH!

PROFITS aren’t REAL MONEY. CASH IS!

EXPENSES on the INCOME STATEMENT do not reflect the CASH going out. The CASH FLOW STATEMENT, by comparison, always tracts CASH in and CASH out during a time period.

Remember all that equipment you bought at the end of the year using up your Section 179 deduction because the sales rep told you it was “deductible” and would save you taxes. Those payments don’t appear anywhere on the income statement. Rather they appear, slowly overtime, month by month, as a DEPRECIATION EXPENSE on the INCOME STATEMENT. The kicker is… those ITEMS are paid for with CASH long before they have been fully depreciated! This CASH outflow appears on the CASH FLOW STATEMENT.

With this in mind, remember that while CASH is KING, CASH FLOW is the QUEEN!

A business can generate PROFITS without CASH, on the flip side a business can also generate CASH without PROFIT.

PROFIT without CASH, is how most small businesses go out of business in their first year. It’s why new restaurants have a hard time gaining traction…they simply run out of CASH and are forced to close. Their expenses outstrip all their cash, and it’s cash that’s required to keep the doors open.

Alternatively, a business generating CASH but no PROFIT is not sustainable for the long term. Eventually the lack of profits will catch up and cause a non-profitable business to run out of CASH.

Alas, all is not lost. Finding the right expertise can help. A firm running out of cash needs FINANCIAL Expertise, while an unprofitable firm needs Operational Expertise to help lower expenses and/or generate additional revenue.

Bottom line is…. a healthy business requires both PROFIT and CASH to maintain financial health.

Let’s Dive In and Dissect and Deconstruct a STATEMENT of CASH FLOW.

This Financial Report is divided into 3 categories:

CASH coming IN is (+), and CASH going OUT is (-).

1. CASH used in OPERATING ACTIVITIES: Which is all cash related to the actual operations of the business. It Includes cash from customers, cash for salaries, vendors, rent, and taxes to name a few.


2. CASH used in INVESTING ACTIVITIES: Which is all cash related to investments made by the company, such as the purchase of capital equipment.


3. CASH used in FINANCING ACTIVITIES: Which is all cash related to borrowing and paying back of loans, as well as the purchase or sale of stock ,or payment of dividends to shareholders.

One can see there is lots of useful information here! We won’t worry about how this report is generated. We will leave those details for your accountant. We will just look at the prepared report.

The FIRST CATEGORY, OPERATING ACTIVITIES

Is one of the most important numbers in all of the financial statements we have examined.

It indicates the Health of a Business.

A company with consistently healthy operating cash flow is probably profitable, and probably doing a good job turning their profits into cash.

With healthy Operating Cash flow a company can finance more of its growth internally without borrowing.

The SECOND CATEGORY, INVESTING ACTIVITY

Shows how much the company is spending on assets to grow the business.

The THIRD CATEGORY, FINANCING ACTIVITY

Shows the borrowing and paying back of loans and dividend payments to shareholders.

What does all of this mean?

Understanding the POWER of CASH FLOW and how to manage it can strengthen your business in several ways;

First, you must understand where the money is coming from and where it is going to. A strong operating cash flow means the business is generating cash. Paying down loans and investing in assets creates negative Investing cash flows which can be very favorable to the long term growth of a business. Selling stock and raising money from shareholders generates positive Financing cash flow which may be a great sign, or it could mean the company is selling stock or taking out debt as a means to stay afloat!

Second, you can directly affect your cash by closely managing your Accounts Receivables, Inventory and Expenses.

Learn to study the Aging of your receivables and calculate and tract your ACCOUNTS RECEIVABLES RATIO which is your Accounts Receivables / Average monthly production. Aim to have this ratio less than one, which means your Accounts Receivables should not exceed your average monthly production. Develop systems to speed the collection of your accounts receivables and you can immediately generate additional positive cash flow. Receivables are the same as giving your customers interest free loans on their balances! The longer it takes to collect your money, the less of it you will have. You should have very few accounts that exceed 90 days!

Similiarly, work to reduce the stock piling of Inventory which uses up your CASH! The quantity discounts suppliers offer may not be saving you money in the long term since holding Inventory and Supplies on your shelfs cost CASH, especially if these supplies expire! I like to remind doctors when they look at all of their inventory and supplies they should be seeing dollars and cents that could be in the bank or in their pockets rather than sitting on their shelfs!

Tighten up your Expenses too. Negotiate more favorable payment terms with your Vendors. Extend out your Accounts Payable, the money You owe your Suppliers. For you, extended payment terms is just like a free loan from your vendor and who doesn’t like FREE!

Evaluate carefully the strategy of prepaying months of rent expense at the end of the year. I know that many doctors are told to do this. This quickly depletes your cash reserve. Tax planning is critical here so consultation with your Tax Professional is essential, but Taxes should not “Wag the Dog!”. Go ahead and take this cash as salary, pay your individual taxes and then use this additional cash to grow your personal Balance Sheet.

Finally, we spoke earlier of a key metric used by Warren Buffett. This metric is “Owner’s Earnings” or “Free Cash Flow”. It is the difference between Operating Cash flow and net Capital Expenditures. Both of these values come from the Cash Flow Statement. Operating Cash Flow is the Total from the top section of the Statement. Net Capital Expenditures can be found as a line item in the Middle Section, the Investing Section, listed as Property, Plant and Equipment.

Companies with healthy Free Cash Flow have many more options to grow, expand operations, invest in equipment, pay down debt and pay dividends to shareholders.

In a dental practice, those shareholders are very likely to be the doctor-owners of the practice!

In Summary , our key take away points are:

1. Cash is NOT subject to the estimates and assumptions present in the Balance Sheet and Income Statement.


2. Profit is NOT CASH. You can’t pay bills or payroll with profits!


3. Healthy Positive CASH FLOW is essential for the long term sustainability and liquidity of a company.


4. CASH flow can be improved by accelerating the collection of outstanding Account Receivables, minimizing the accumulation of excess inventory and closely monitoring the timing of Expenses.

So that wraps things up for this Podcast.  Hopefully you have a better understanding of the mechanics of the STATEMENT OF CASH FLOWS. We hope that this information has created a few “Ah Ha” moments, or stimulated some additional questions you can direct to your advisers or accountants.  We welcome your inquiry here too at OmniStar Financial.  Our contact information can be found at our website OmniStarfinancial.com  .  You will also find a link to sign up for our newsletter.  Please share this podcast if you found it helpful, and leave a review on iTunes too.  We welcome your feed back and suggestions for future podcast sessions.  You can always find me, your host, david darab, at my twitter handle, @ddarab.

Thank you so very much for tuning in and listening.  We are very grateful for your time and attention and so very pleased to have you in our audience.

REFERENCES:

Financial Intelligence, Revised Edition: A Manager’s Guide to Knowing What the Numbers Really Mean: Karen Berman, Joe Knight, John Case: 8601406238220: Amazon.com: Gateway

Stark Naked Numbers: Uncover Your Financials, Unlock Your Cash, and Unleash Your Profits: Mr Jason Frederick Andrew: 9780648424000: Amazon.com: Books

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