Over the years, I have seen many business clients pay an excessive amount of attention to the income or profit and loss statement to the detriment of the other financial statements available, such as the balance sheet, the statement of cash flow and statement of owner equity.
Here’s an interesting example. A company paid almost exclusive attention to its profit and loss statement. Everything looked great except a couple of years later, it was discovered that the in-house bookkeeper had made serious errors in classifying expenses, which resulted in an overstatement of income, which resulted in excessive compensation payments and an inflated value for the business when some of the owners were bought out. Had management utilized a statement of cash flow, they would have seen that some of the cash coming in was by way of advances from affiliated entities and not by way of revenue from sales. And if they had studied their balance sheet, they likely would have noticed that something was askew by looking at the cash balance on each year-end balance sheet closing date vs. net profit shown on the profit and loss statement for each annual perios.
While many small businesses don’t use the statement of cash flow, it can be a very valuable tool. It reconciles how your cash balance changed between the beginning of the year and the end of the year by analyzing cash in and out from operations, cash in and out from investment activities, and cash in and out from financing activities.
Check with your company accountant to see if statement of cash flow would be a useful tool for your business as a part of your annual financial statements. The example above was a situation where it would have been of great value.
Disclaimer: This blog is for information purposes only. Legal advice is provided only through a formal, written attorney/client agreement.