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Sources and Uses of Funds

Sources and Uses of Funds

In our ongoing discussion of risk throughout 2018, the multiple risk factors identified boiled down to one core flaw that brought down the majority of failed contractors – a shortage of capital. For one reason or another, the failed contractors simply ran out of money. What’s more, the CEOs were often surprised by their firm’s sudden collapse. 

We attributed these failures to the fact that most construction industry CEOs failed to utilize traditional financial controls and often didn’t even include their CFOs in executive management decision making. This judgment, however, was perhaps premature, incomplete, a little too harsh, and missed some fundamental flaws in the creation and use of traditional financial statements themselves.

Snapshot

The Income Statement and The Balance Sheet are the backbone of modern financial reporting. When properly prepared and analyzed, they provide management, investors, bankers, and sureties with an accurate picture (a snapshot) of a company’s financial condition at a moment in time.

Game Film

However, continuing research and discussions with construction industry CEOs throughout 2018 gave us a deeper insight into why they often don’t rely on these financial reports to manage their business.

“Our industry is too fluid and fast moving to be reduced to a frozen set of static numbers. Our business never stands still. Things are always changing and flowing, and I can’t get any real insight into what’s going on just by keeping score. I need to see the game films,” one CEO told me recently.  

A football coach cannot decide why his team lost the game simply by knowing the score. He must watch the game film to see clearly what went wrong and coach his team beyond the errors. The construction industry is fast moving, ever changing, and highly competitive just like a great college football game. Contractors must be able to see where their cash was used in order to understand their capital position at the end of an accounting period. Just like football game film, the statement of cash flows provides an active portrayal (like a film rather than a snapshot) of where all the money went.

Statement of Cash Flows

The Statement of Cash Flows tracks the ins and outs of cash, revealing how and where cash was used throughout the accounting period.

Because the income statement is prepared under the accrual basis of accounting, the revenues reported may not have been collected. Similarly, the expenses reported on the income statement might not have been paid. You could review the balance sheet changes to determine the facts, but the cash flow statement has already integrated all that information.

While the statement of cash flows in primarily a tool used by CFOs, some savvy construction executives use this financial statement as their “game film”.  It not only informs management of what their cash position is but tells them why it is what it is. Where did the money go? What was it used for? Admittedly the cash flow statement is difficult for all but accountants to read and understand but it contains valuable information.

Sources and Uses

In order to answer the question, “where did cash come from and where did it go?”, the cash flow statement is divided into three sections:

  1. Cash Provided From or Used by Operating Activities. This section of the cash flow statement reports the company’s net income and then converts it from the accrual basis to the cash basis by using the changesin the balances of current asset and current liability
  2. Cash provided From or Used by Investing Activities. This section of the cash flow statement reports changesin the balances of long-term asset accounts like land, buildings, equipment, furniture and fixtures, and vehicles.
  3. Cash Provided From or Used by Financing Activities. This section reports changes in balances in the long-term liability and stockholders’ equity

Start Here

If you’re used to giving your financial statements a cursory glance at the end of each month you are missing an important tool. If you use and understand the income statement and balance sheet and want to take a deeper dive, consider learning how to read the Statement of Cash Flows. Your financial statements are as essential to managing a construction company as game film is to coaching a football team. We will discuss these in more detail in future blogs.

Read more about the Let’s Talk Business Manual and Simplar.com