Cash Flow Statements Tell a Story

Lenders that use the statement of cash flows as an assessment tool can gain insight into their customers’ financial health, cash management skills and loan worthiness. But they need to understand what they’re seeing — or they could draw the wrong conclusions.

How are They Structured?

Always a component of audited financial statements, the statement of cash flows also might be available from other financial statement presentations, such as a compilation or borrower-prepared statement. It consists of three sections:

1. Cash flows from operations. This section converts the business’s accrual net income to cash provided or used by its operations. All income-related items flow through this part of the statement, such as net income, gains (or losses) on asset sales, depreciation and amortization, and net changes in accounts receivable, inventory, prepaid assets, accrued expenses and payables.

2. Cash flows from investing activities. The second section of the statement is a primary indicator of solvency. If a company buys or sells property, equipment or marketable securities, the transaction shows up here. This section might reveal that a company is reinvesting in its future operations — or divesting of assets for emergency funds.

3. Cash flows from financing activities. This last part reveals your customer’s transactions with investors and lenders. It shows the company’s ability to access cash via either debt or equity. This segment also indicates how the company leveraged its balance sheet to avoid cash crunches — one indication of how well it might navigate through a sluggish economy.

What Should You Look For?

The statement of cash flows shows changes in balance sheet items from one accounting period to the next. Make sure you inquire about significant balance changes. For example, if accounts receivable were $3.5 million in 2011 and $4.5 million in 2012, the change would be reported as a cash outflow from operations of $1 million. That’s because more money was tied up in receivables in 2012 than in 2011.

An increase in receivables is common for growing businesses, but a mounting receivables balance also might signal cash management inefficiencies. And an aging schedule might reveal significant, potential loss write-offs. This is important information if you’re a lender that relies on accounts receivable as collateral. Be specific with the type of business you’re analyzing. In some cases — for example, in a retail operation that’s dependent on cash sales — receivables shouldn’t grow.

Also beware of businesses that continually report negative cash flows from operations. When operating outflows consistently outpace operating inflows, it’s time for intervention.

How Should You React to a Troublesome Statement?

Let’s say you spot cash shortages in the statement of cash flows, and you suspect your business customer is struggling operationally. This can impair repayment ability, which hurts the business’s credit risk rating with the bank, and subjects the bank to higher reserve balances and added regulatory scrutiny.

You may wish to advise borrowers to consult with their CPAs or accountants to identify the trouble areas and provide suggestions to help improve cash flow. A change in business operations may be a hard pill for an entrepreneur to swallow. But in the short term, you’ll likely help your customers find some hidden sources of cash.

The Truth Behind the Numbers

Don’t let the mass of numbers in a cash flow statement turn you off. Although the statement is a collection of figures, this document also can tell you a great deal about your prospective borrowers’ ability to manage finances — and the risks they present to your lending operation.

For more information on how we can help your community bank, please contact Sonny MacArthur at or 404-420-5631.