Monthly Archives: January 2015

Make the Statement of Cash Flows One of Your Most Trusted Tools

And why you need better control over the preparation of this statement…

By Alan Hart, MBA

I just read article “SEC Nudges Companies on Cash Flows”, written by Compliance Week author, Tammy Whitehouse.  It refers to a study done by the SEC of cash flow restatements, as conveyed by T. Kirk Crews, Professional Accounting Fellow, Office of the Chief Accountant, U.S. Securities and Exchange Commission.  Findings suggest that the majority of errors were due to poor internal control over financial reporting, as well as too much reliance on end-user computing tools, such as spreadsheets. The article continues to explore the various possibilities leading to these errors, and stresses the importance of having the right processes in place with the appropriate internal control framework and full understanding of FASB ASC 230 – Statement of Cash Flows.

The Statement of Cash Flows is one of the most important financial statements in any organization and along with the Balance Sheet conveys the financial health of the company.  It is required by the SEC in all annual (FORM-10K) and interim (FORM-10Q) filings and is common practice in all audited and reviewed financial statements prepared by external auditors for privately held companies.

Unfortunately, the Statement of Cash Flows is often misunderstood by many accounting and finance professionals and its many benefits are not given the weight they deserve.  This is particularly true for a forecasted Statement of Cash Flows, rarely seen in the planning and budgeting process of many enterprises.

Why is the Statement of Cash Flows so important?

The Statement of Cash Flows shows the sources of all cash receipts and cash outlays segregated into three major categories:

1)    Cash Flows from Operations
2)    Cash Flows from Investing Activities
3)    Cash Flows from Financing Activities

Whether the direct method or the indirect method are used, all cash receipts from customers, loan proceeds, sale of company stock, sale of assets and other sources are clearly listed on the statement, each appearing in one of the three categories listed above.  All cash outlays such as payments to suppliers, employees, taxing authorities, interest payments, payments for investments in other entities, and payments for acquisition of assets also appear in these three categories.

The rules surrounding the preparation of the Statement of Cash Flows have been published (including updates) by FASB under Topic 230, readily available to review and use.

As we clearly see, a properly prepared Statement of Cash Flows will give us a good idea on where cash is coming from and where it is going.  The data needed to prepare a Statement of Cash Flows comes primarily from the Balance Sheet (beginning and ending balance sheets) and the Income Statement will provide other needed data.  The period covered by the Statement of Cash Flows must match the period covered by the other financial statements.

In the case of a forecasted Statement of Cash Flows used for planning and budgeting, the benefits of having an accurate and complete statement are:

1)    Projecting and understanding how much cash will be received in each planning period from the three identified cash flows categories.
2)    Projecting and understanding how much cash will leave the organization via payments to suppliers, employees, taxing authorities and other entities, segregated by the three cash flows categories.
3)    Projecting and understanding cash requirements during the planning period and arranging for financing, sale of assets and other activities in order to meet the anticipated cash needs and well ahead of time.

My observation and experience is that many ERP and accounting software solutions do not have a “canned” report to produce a proper Statement of Cash Flows, leaving users to either program it themselves in their ERP system or resort to using spreadsheets, as most people do.  As we have seen before on this blog, spreadsheets are not the right tool to produce financial statements (Link to: Think your spreadsheet files are dependable? Blog entry goes here).

The right solution is to have more ERP and accounting software vendors provide a pre-programmed template for this statement where users can link their GL account or account groups to various components of the Statement of Cash Flows.

As far as planning and budgeting solutions are concerned, I’d like to see an integrated Statement of Cash Flows, with an integrated balance Sheet and Income Statement.  These statements should be automatically generated from the aggregation of all user forecasted data and with the use of the beginning Balance Sheet account balances, will produce a complete and accurate set of financial statements for every period participating in the budget.

Readers of this blog know that with a software application like Budget Maestro, forecasting an accurate and complete Statement of Cash Flows is reality.  An accurate and complete Statement of Cash Flows is at the top of my list, along with the Balance Sheet, both for actual accounting and for budgeting.  There is little wonder now why the SEC is urging companies to take a closer look at their internal control over financial reporting, particularly the preparation of the Statement of Cash Flows.

Can You Predict Your Future Physical and Mental Health? A Budgeting & Forecasting Analogy

Probably not in the near future but your business can (its financial health that is)…

I just left my doctor’s office after completing my annual checkup.  While everything seemed to be in order I had a quick discussion with him on whether or not it would be possible with the new advances in medicine to accurately predict one’s future physical and mental health based on their current health, family history and perhaps other factors.

Imagine a system where all your health history, current vital signs and other pertinent information was in a computer database and while performing certain tests, the additional information was added to the existing data and a forecast or prediction of your future health became available to read and analyze.

This seems rather futuristic and perhaps unattainable. Nonetheless, it is a very intriguing idea.  What if we could start a preventive maintenance program in response to some prediction of a future health issue or disease?  This would be in addition to using existing well-known methods of maintaining health through proper diet and exercise.  Of course, some people may not want to know their future medical and mental health for various reasons but I think the majority of us will want that.

While we would have to wait for this technology to become available, we do have the ability today to predict and forecast a different kind of health.  What I am referring to is the future financial health of a company.  Unfortunately, many organizations are not aware of this, or are so wrapped up in their old financial processes that this hasn’t yet become reality.

Many companies that prepare their budgets and maintain them through re-forecasting often don’t fully benefit from these activities.  Even if the budget does not remain static throughout the budget time horizon, the information obtained from this process is limited and sometimes misleading.

Here’s a good example:

A budget only generating a forecasted income statement (P&L) for each period in the budget does not even begin to tell the entire story.  Without a budgeted balance sheet (and the derived statement of cash flows) you cannot forecast vital information such as available cash balances, cash needs, future receivables and inventory levels, future payables and other debt obligations, ability to meet loan covenants and many other crucial pieces of information.

You may have an insightful forecasted set of revenue lines and expenses. However, can you say with confidence that you’ll be able to achieve these revenues at the forecasted costs?  Will you have sufficient cash to do that?  What about maintaining debt covenants?  Will your inventory levels and accounts receivable be sufficient for you to adequately draw on your line of credit?

The answer to these questions is no.  With only a forecasted income statement you can’t possibly forecast the financial health of your company in future periods.

What about the available technology?

Observing advancements in finance software in the last 10-15 years, I see a new trend emerging:  A complete planning, budgeting and analysis software solution that takes all user programming and formula work out of the process, while allowing users to collaborate on preparing a budget, using pre-defined system business rules, working with drivers and other allocation tools and automatically generating a complete set of future period financial statements.

Centage Corporation’s Budget Maestro with Analytics Maestro is a great example of such a system and several articles on this blog make reference to this software and the various benefits enjoyed by its users.

When you are able to gain insight into the future financial health of your company you are able to better plan for the future, make more intelligent decisions and avoid mistakes due to lack of data, or bad data.

Since we cannot yet predict our future physical and mental health let’s stay healthy doing what we know today but forecast the future financial health of our companies with the technology that is here now.