The third type of financial statement is a statement of cash flows. These are not commonly prepared for small businesses, which I think is a real mistake as they are an excellent indicator of the strength of the business. Even worse, they are almost never prepared for an individual. A company could be making income (shown through the income statement) and yet go broke. And an individual could have money in an account and still be on the way to financial ruin. Here’s an example of how a business could have a strong income statement and a solid balance sheet and go out of business.
The statement of cash flows is different from the other two statements—the balance sheet and the income statement—as the statement of cash flows starts with the net income and then adjusts from there. In Figure 1.1, look at how “What’s Left” flows through to the top line of the statement of cash flows. The amount is then adjusted by cash that is provided (or taken by) operations, cash that is provided by (or taken by) financing, and cash that is provided by (or taken by) investing.
In Odetta’s case, the operations section was taking all of her income. A statement of cash flows would show that the cash flow at the end was negative. That’s a danger sign!
It’s also a danger sign to see cash flow provided by extensive finance.
