n a pure cash only operation, the profit as reported on the income statement would also be cash flow from operations. But modern-day business is not pure in how it is conducted. Companies agree to pay suppliers at a later time, payroll is weekly or monthly, benefits that are paid in the future are offered to employees, credit is extended to customers; the list can go on and on.
Cash Flow – A Basic Definition
Cash flow is the ability of a business to turn its product or service into cash. It is generally measured in dollars or in dollars against a time period. The simplest example I can think of is a child selling lemonade. The child purchases the lemonade and sugar in the morning, starts selling in the afternoon and by nightfall has turned all the lemons and sugar into cash. The child has the cash invested (lemons and sugar) back plus the profit made that day. However, it isn’t this simple in the real business world.
Financial statements serve the purpose of presenting economic activity and status related to a particular date and over a particular time frame. Accountants record monetary transactions and via financial reports present the information in an easy to understand format. The financial statements for a small business do not have to comply with those of publically traded operations.
Every business owner needs to know the difference between insolvency and bankruptcy. Often these two terms are misunderstood and improperly used in conversation. You need to know their correct meaning because both are used in civil law and both have different issues to address during the process. In addition, understanding these two terms builds a better comprehensive understanding of financing your business.
The quick ratio is a formula used in business to identify the ability of a business to pay its current liabilities. It is also known as the ‘Acid Test’ formula (ratio). In the large markets this formula is one of the financial industry ratios used to value the stock of a corporation. In the arena of the small business, you should only use this ratio as a means to gauge ability to pay your bills right now.
Accrual accounting is the preferred method of accounting for all business operations. Any publicly traded company must comply with the principles of accrual accounting. Small business operations can choose between cash and accrual accounting for their records. Although cash accounting is the easiest to work with as a small business operation, accrual accounting will provide a more accurate picture of the financial status and affairs of any business operation.