As someone who’s been involved in business and side hustles since my teen years, understanding the P&L has always come naturally. Expenses, revenue, and profit; they’re all terms we use in everyday language. So when a small business owner looks at a P&L for the first time, it probably makes immediate sense. It just clicks.
The Balance Sheet is equally intuitive. Most people get the gist of what they own, what they owe, and what’s left over. It’s the kind of stuff that even comes up when you’re talking about mortgages or car loans.
But the Statement of Cash Flows doesn’t have a common, simple analogy to our daily lives. I didn’t truly appreciate it until my MBA, and even then, it wasn’t until I managed cash flow firsthand that I realized just how critical it is to business survival. Especially as a planning tool.
It’s arguably the most important report of all the statements.
If it doesn’t jingle, it doesn’t count. —James Hatch
The quote is from my MBA finance prof, Jim Hatch.
The concept that cash is king is so vitally important that on the first day of any finance course I give I write the question, with the two blanks, and then fill them in. Then I would tell them that this would be the bonus question on the final exam.
And then tell them again in every class!
Why the P&L Misleads
You’re showing a profit but your bank account tells a different story. What’s going on?
Many small business owners have experienced this: the P&L looks great, but you’re worried about covering payroll or paying suppliers. It’s like having a fitness tracker that says you burned 500 calories today, and you’re about to pass out from hunger.
The reason is simple: the P&L measures profitability, not cash. And while profit is important, it doesn’t mean much if you don’t also have liquidity. If you’re growing, cash will almost always lag profits. As a result, you will often have cash flow issues that the cash flow statement can help you to understand. It can, in fact, help to predict them—and then avoid them.
Profit ≠ Cash: Profit is malleable. Depreciation, bad debt allowances, and revenue timing can all distort it. A small business owner can make profit appear better or worse simply by adjusting spending or accounting methods, but none of that will change the underlying cash situation.
“In a small company, profit is whatever the owner says it is.”
—Brad Poulos
The CFS, by contrast, cuts through the noise. It gives you a clean view of where money is piling up, or leaking out. Details that you won’t see in your P&L.
Cash Doesn’t Lie: The Statement of Cash Flows
The Statement of Cash Flows or Cash Flow Statement (CFS) simply tracks how cash actually moves through your business. It organizes inflows and outflows into three broad categories that represent the three major functions or activities of any organization:
Operating Cash Flow
This is the cash generated (or used) by your core business activities. It includes all sales and expenses but also balance sheet changes like purchases of inventories, or payments from customers and to suppliers. This section will add any non-cash expenses like depreciation/amortization because these are “expenses” but don’t involve a cash outlay.
Operating Cash Flow should normally be positive in what I call a Normal Healthy Growing Company (or NHGC), which is a business that’s profitable, generating positive operating cash flow, and reinvesting in itself at a sustainable pace. [Read more about Brad’s concept of an NHGC here].
If your core operations aren’t spinning off positive cash, you’re either funding losses through loans, burning through reserves, or selling off assets to pay the bills. None of these are sustainable.
Positive operating cash flow is the financial heartbeat of a healthy business. It proves that the business model works, and that growth is being driven by actual performance, not by borrowing or asset sales.
Investing Cash Flow
When a company “invests” we mean investing in long-term or fixed assets that will be used to generate revenue in the business. This includes items like equipment, vehicles, computers, or real estate. These transactions don’t happen every day, but they’re critical for growth and strategic direction. So if this section shows negative cash flow, it is generally a good sign. It means you’re investing in the future of the business. If it’s consistently positive, it may indicate you’re selling off assets—potentially a red flag, depending on the context.
Financing Cash Flow
Financing activities capture the cash moving in or out of your business from lenders, investors, or owners. This includes taking out loans, repaying debt, injecting owner capital, or paying dividends. If you see cash flowing into the business here, it might mean you’re taking on debt or raising capital. If it’s flowing out, you’re repaying loans or distributing profits.
How to Read the Statement (Without Falling Asleep)
Watch this line: “Net Increase (or Decrease) in Cash” or “Net Cash Flow.” This number explains the change in your actual bank balance over the reporting period. If your business isn’t constantly lighting your hair on fire and your net cash flow is regularly positive, you’ve earned the right to unclench, at least a little. Look at bit deeper to reveal whether your business is heading in the right direction. If your operating cash flow is strong and consistently positive, that’s the ideal scenario. But if it’s negative, that’s a major red flag. It means your business operations are consuming more cash than they’re generating, and someone is financing losses. You need to investigate and act quickly. Find out why your operations are consuming cash. Do you have a healthy gross profit margin? If so, look at your working capital. You might be slow collecting or overdoing the inventory levels. Conversely, a negative cash flow from investing activities is a good sign. It means that you’re buying equipment or assets to support future growth. On the other hand, if you’re consistently showing positive investing cash flow, it might mean you’re selling off business assets just to stay afloat. The biggest concern arises when you see positive financing cash flow combined with negative operating cash flow. That combination usually indicates you’re borrowing just to keep the lights on. It’s not a sustainable model and should trigger immediate attention.What a Small Business Operator to Do?
Review your Cash Flow Statement every month, not just at tax time. Then use it to ask better questions like: Are we generating cash from operations? Are we collecting from customers fast enough? Are we investing ahead of our means? Then take action. Chase overdue invoices. Trim excess inventory. Delay spending that’s not urgent. Renegotiate supplier terms. All of it shows up in the cash flow statement—you just have to look.Budgeting with the Cash Flow Statement:
When you budget using all four key financial statements, including the CFS, you gain the ability to forecast future cash crunches or surpluses. A good budget is monthly, not annual, and it doesn’t just estimate revenue and expenses. It tracks when money will actually move—including loan payments, capital purchases, inventory buys, and owner draws.
Here’s what a smart budget framework includes:
- P&L (Income Statement): Measures your revenue and expenses over time.
- Statement of Retained Earnings: Shows how profits are split between reinvestment and distributions to owners.
- Balance Sheet: A point-in-time snapshot of what you own, what you owe, and what’s left for the owners.
- Cash Flow Statement: Breaks down cash movement during a period across operating, investing, and financing activity.
Together, these statements give you a full picture of your business’s financial condition. But it’s the CFS that shows what’s really going on with your cash, which is what keeps the lights on.
You don’t need to be an accountant to do this. Brad has an Excel planning tool that will allow you to create a 3-year budget and financial statements without knowing any accounting.
Get Brad’s Budget Planning Tool here.
If you’d like a more in depth explanation of the cash flow statement, check out this article on appeconomyinsights.com.
https://www.appeconomyinsights.com/p/how-to-analyze-a-cash-flow-statement
