82% of Small Businesses Fail Due to One Issue—Here’s How to Avoid It

As a business leader, understanding your company’s financial health is key to making strategic decisions. However, reviewing financial documents, like the cash flow statement, can feel overwhelming, especially if you don't have a finance background. According to a study by Jessie Hagen, 82% of small businesses fail due to poor cash flow management, and only 40% of small business owners say they feel confident in their financial literacy. The good news is that you don’t need to be an accountant to make sense of a cash flow statement. 

In this article, we’ll break down the basics of cash flow statements in a straightforward way. By the end, you’ll be equipped with practical steps to assess your company’s financial performance, improve cash flow, and make data-driven decisions.

Where do I Get My Cash Flow Statement?

Before we jump into the details, pull up a copy of a recent cash flow statement for your business. A cash flow statement is usually available as a report in your accounting software. Tools like QuickBooks, Xero, or FreshBooks provide automated cash flow reports based on transaction data put into the system. Alternatively, if you have an accountant or bookkeeper, they may prepare the cash flow statement manually or through accounting software. As a last resort, you can generate one on your own by reviewing your business’s bank statements and organizing the transactions according to cash inflows and outflows over a specific period. There are many free cash flow statement templates available online.

What is a Cash Flow Statement?

A cash flow statement shows how cash moves in and out of your business during a specific period. It helps you understand whether your company is generating enough cash to cover its expenses and fund growth.

This financial document is divided into three main sections:

1. Operating Activities
2. Investing Activities
3. Financing Activities

Let’s explore each section in detail to understand how they contribute to your business strategy. 

Keep in mind that many businesses when just starting out have operating activities only. So, even if you don’t have investing or financing activities right now, take a minute to read those sections below to get familiar with those components of a cash flow statement.

1. Cash Flow from Operating Activities

The operating activities section covers cash generated from your core business operations, such as sales of products or services. This is the most important part of the cash flow statement because it reflects the daily workings of your business.

What to Look For:

Positive Cash Flow: If your operating activities generate more cash than they use, your business is likely performing well. This indicates efficient process improvement and operational stability.

Negative Cash Flow: If you're spending more cash than you're earning from operations, it might signal operational inefficiencies or higher costs. Consider looking at performance optimization strategies to reduce expenses and boost revenue.

• Positive Cash Flow: If your operating activities generate more cash than they use, your business is likely performing well. This indicates efficient process improvement and operational stability.
• Negative Cash Flow: If you're spending more cash than you're earning from operations, it might signal operational inefficiencies or higher costs. Consider looking at performance optimization strategies to reduce expenses and boost revenue.

Pro Tip: Focus on improving cash flow from operating activities before anything else. Strong operations are the foundation of a profitable business.

2. Cash Flow from Investing Activities

The investing activities section tracks the cash spent on or generated from buying and selling long-term assets, like equipment, property, or investments.

What to Look For:

Negative Cash Flow from Investing: This often indicates that the company is investing in future growth. For example, technology implementation or buying new equipment may cause short-term negative cash flow but lead to long-term profitability.

Positive Cash Flow from Investing: Selling assets can generate cash, but too much of this may be a red flag if it suggests your company is offloading essential assets to cover costs.

• Negative Cash Flow from Investing: This often indicates that the company is investing in future growth. For example, technology implementation or buying new equipment may cause short-term negative cash flow but lead to long-term profitability.
• Positive Cash Flow from Investing: Selling assets can generate cash, but too much of this may be a red flag if it suggests your company is offloading essential assets to cover costs.

Practical Tip: Evaluate the long-term impact of your investments. If you're spending cash on growth initiatives like business transformation or expanding operations, ensure these will generate future returns.

3. Cash Flow from Financing Activities

The financing activities section includes cash received from or paid to investors and lenders. This could involve issuing stocks, taking on debt, or paying dividends.

What to Look For:

Positive Financing Cash Flow: If you’re raising capital through loans or equity, this will boost cash flow. However, relying too heavily on external funding could increase financial risk, affecting your company's long-term sustainability.

Negative Financing Cash Flow: Paying off debts or issuing dividends typically causes cash outflow. While this reduces cash reserves, it’s a sign of strong financial health if done sustainably.

• Positive Financing Cash Flow: If you’re raising capital through loans or equity, this will boost cash flow. However, relying too heavily on external funding could increase financial risk, affecting your company's long-term sustainability.
• Negative Financing Cash Flow: Paying off debts or issuing dividends typically causes cash outflow. While this reduces cash reserves, it’s a sign of strong financial health if done sustainably.

Risk Management Tip: Balance raising capital and paying off debt. Strong cash flow from financing activities should align with your business strategy and long-term goals.

How to Analyze Cash Flow Trends

Rather than looking at just one period’s cash flow statement, it's better to review trends over time. Consistent negative cash flow could indicate deeper operational issues, while steady positive cash flow signals business stability.

Here are some practical tips to help you:

Compare Cash Flow to Profit: Profit and cash flow aren’t the same. A profitable business can still face cash flow problems. Focus on optimizing cash flow to ensure there’s enough cash to keep operations running smoothly.

Watch for Timing Issues: Delays in accounts receivable or excessive inventory can hurt cash flow. Streamline billing processes or adjust inventory management to ensure a healthy inflow of cash.

Monitor Cash Availability: Cash flow statements are a vital tool for data-driven decision-making. Understanding how much cash you have on hand or readily available (also referred to as liquidity) can help in project management and funding new initiatives.

• Compare Cash Flow to Profit: Profit and cash flow aren’t the same. A profitable business can still face cash flow problems. Focus on optimizing cash flow to ensure there’s enough cash to keep operations running smoothly.
• Watch for Timing Issues: Delays in accounts receivable or excessive inventory can hurt cash flow. Streamline billing processes or adjust inventory management to ensure a healthy inflow of cash.
• Monitor Cash Availability: Cash flow statements are a vital tool for data-driven decision-making. Understanding how much cash you have on hand or readily available (also referred to as liquidity) can help in project management and funding new initiatives.

3 Common Cash Flow Pitfalls to Avoid

Even experienced CEOs make mistakes when reviewing cash flow statements. Here are some common errors to watch out for:

1. Ignoring Operating Cash Flow

Focusing too much on sales and profits without reviewing cash flow from operating activities can give you a distorted view of your financial health. Operating cash flow is the best indicator of how well your business runs day-to-day.

2. Overlooking Cash Flow Timing

Even if your business is profitable, slow payments from customers can create cash flow problems. Use tools like technology implementation to automate invoicing and payment reminders.

3. Failing to Plan for Seasonal Fluctuations

Many businesses experience seasonal variations in cash flow. Plan ahead for leaner months by maintaining a cash reserve to cover expenses during downturns.

Practical Tips for Improving Cash Flow

Now that you understand how to read a cash flow statement, here are a few ways to improve cash flow and maintain financial stability:

Negotiate Better Payment Terms: Shorten your accounts receivable cycle by offering discounts for early payments or imposing penalties for late ones.

Cut Unnecessary Costs: Conduct a process improvement audit to find and eliminate inefficiencies that drain cash flow.

Boost Operational Efficiency: Implement systems that allow for more performance optimization, such as automation tools or outsourcing non-core activities.

• Negotiate Better Payment Terms: Shorten your accounts receivable cycle by offering discounts for early payments or imposing penalties for late ones.
• Cut Unnecessary Costs: Conduct a process improvement audit to find and eliminate inefficiencies that drain cash flow.
• Boost Operational Efficiency: Implement systems that allow for more performance optimization, such as automation tools or outsourcing non-core activities.

Bonus Tip: Evaluate your customer experience and identify opportunities to streamline service delivery. A smooth, efficient customer journey not only improves satisfaction but also accelerates cash collection.

Start Taking Control of Your Cash Flow Today

Reviewing a cash flow statement doesn’t need to be complicated. By understanding the key components—operating, investing, and financing activities—you can make more informed decisions that improve both your short-term and long-term business health.

Strong cash flow is vital for business strategy, growth, and risk management. Regularly reviewing and optimizing your cash flow will allow you to make better data-driven decisions, reduce stress, and drive sustainable growth.

For more information, visit my website at 3SSmartConsulting.com or if you have questions, email me at hello@3SSmartConsulting.com. I’m here to help you turn financial statements into strategic tools for growth!