Thursday, October 1, 2009

QuickBooks Statement of Cash Flows is Wrong for these Three Reasons

The statement of cash flows is the most valuable, the most under-used, and the least understood of the three main financial statements (profit & loss, balance sheet, statement of cash flows). Since a lot of businesses use QuickBooks, I feel it is critical to make sure we all understand what needs to happen to make this reporting feature more accurate.The statement of cash flows is the most valuable, the most under-used, and the least understood of the three main financial statements (profit & loss, balance sheet, statement of cash flows). Since a lot of businesses use QuickBooks, I feel it is critical to make sure we all understand what needs to happen to make this reporting feature more accurate. It is likely that our QuickBooks-generated statement of cash flows is incorrect for the following three reasons:

CLASSIFICATION OF ACCOUNTS
Each time a QuickBooks user creates a new account the system looks at the type of account and, if that account type is on the balance sheet, it is classified into one of the three sections of the cash flow – cash from operations, investing, or financing. QuickBooks is often right in its inclusion of accounts on the statement but it can be very wrong on the section of the statement in which the account should be included.  For example, a working capital line of credit is often coded as a current liability. QuickBooks assumes this account should be in the operating section of the cash flow, but that is not always the case. A line of credit is usually reported in the investing section of the statement.  The classification of all accounts can be manually changed in QuickBooks by going to Edit, Preferences, Reports and Graphs (Company Preferences), and then click on the Classify Cash button in the Statement of Cash Flows section. An account is placed on the report when a checkmark is next to the account in one of the three fields, which represent each section of the report.

DEPRECIATION
The whole purpose of the statement of cash flow is to adjust the net income reported on the profit and loss to the cash position of the company. Depreciation is a non-cash expense, and, therefore, is added back to net income as a first order of business on the statement of cash flow. Since depreciation is not a balance sheet item, QuickBooks, by default, does not even include it on the statement of cash flows. QuickBooks does, however, include accumulated depreciation on the report, but it is reported in the investing section (depreciation is technically part of the operating section).  To correct this situation, two things must be done. First, follow the instructions above and remove the accumulated depreciation account from the report. Second, add the depreciation account to the operating section.

CHANGES TO PRIOR PERIODS
This issue causes problems with all three of the financial statements. Once a period is complete, all of the accounts are reconciled, and financials have been issued, there should be no more changes to that period or earlier. By simply using the Closing Date and Password functionality of QuickBooks, the company can lock prior periods and protect them from any attempts to add to, delete from, or change any transactions in the closed periods. This is easy to use and can save the business from a lot of headaches in the near and long-term, not to mention safeguard the accuracy of it’s reporting. This is done by going to Edit, Preferences, Accounting (Company Preferences), and then clicking on the “Set Date/Password” button in the Closing Date section. This will allow you to set the date of the close as well as only allow people to make changes prior to that date if they know the closing date password.

CONCLUSION
If I could only receive one of the three financial statements, I would always pick the cash flow statement. It is the most valuable for any business, especially start-up and emerging businesses. It is the best measurement tool of cash sources and uses for any business, especially start-up and emerging businesses.  By setting up QuickBooks correctly and then using it correctly it is capable of cash flow reporting that will help entrepreneurs and CEO maximize their cash flow.