Cash flow analysis might sound like something only large corporate finance teams would measure, but it is valuable across businesses of all sizes. It can also be as simple or complex as you want to make it.
Dive into why analyzing cash is essential for measuring a healthy business, what role it plays in financial reporting, and how you can use forecasting to anticipate your future cash needs.
In this article, we will cover:
What is cash flow?
The term refers to the inflows and outflows of cash within your business during a period, say a quarter or a fiscal year. It’s important to note this is different from your company’s profit, although both measures are vital in assessing financial performance.
What is cash flow analysis?
Analyzing cash involves an assessment of the timing of cash movements, how much is transferred in and out, and future cash predictions. Understanding cash flow is one of the main objectives of financial reporting. It allows a company to see its liquidity and flexibility. Positive movement shows a company’s liquid assets have increased, meaning it can cover its day-to-day operations, pay creditors, reinvest, and provide a cash buffer for any future financial challenges.
Why cash flow analysis is essential for a healthy business
Analysis provides essential information on your company’s financial health. It tells you where your cash inflows are coming from: Loans, sales, or investors. And it tells you where you are spending your money. Newer businesses may experience negative operating cash flows to begin with if they’re spending on growth, which is okay if investors and lenders are happy to support the business. But a business can’t sustain negative cash flows in the long term and must be able to operate as a going concern.
Businesses can also use cash flow forecasting to predict whether they may come into cash flow trouble in the future. Creating a cash flow forecast will help manage the timing of cash inflows and outflows.
What is the cash flow statement?
The cash flow statement is one of the 3 main financial statements and is generally used alongside the balance sheet and the profit and loss statement (also known as the income statement).
To analyze your company’s cash flow, you need a cash flow statement, as the profit and loss statement includes non-cash transactions as well as accruals. It is the cash flow statement’s role to show pure cash movements for the period.
The cash flow statement helps you get a picture of how your business manages its cash position because you can see both the sources and uses of cash. Being able to understand not only how much cash was spent, but also where, gives you contextual information you won’t receive from other financial statements.
What are the 3 types of cash flow in a company?
There are 3 sections included on the cash flow statement: Cash flow from operating activities, cash flow from investing activities, and cash flow from financing activities (this is the order they appear on the statement).
Cash flow from operating activities, or operating cash flow, describes the movements of cash used in your everyday business operations. So, it tells you how much cash was generated in sales of your products or services. Cash receipts also include other operating income like commissions and interest received. Cash payments include the costs of running the business, like salaries, rent, and office equipment.
Cash flow from investing activities, or investing cash flow, describes the cash spent on growing your business through capital investment. This includes physical assets and non-physical assets like patents, as well as the cash you receive from selling those investments. Negative cash flow from investing activities might indicate a focus on investing in long-term growth such as research and development, so is not necessarily an indicator of poor health.
Cash flow from financing activities, or financing cash flow, shows the cash used to fund the business from the owner(s), investors, or creditors. Receipts can include business loans from banks, mortgages, and other borrowed funds. Cash payments include dividends paid to shareholders.
Step-by-step cash flow analysis
Understanding your cash flow will empower you to make the best possible business decisions. Here are 5 steps to perform cash flow analysis:
- Gather financial statements—start by collecting all relevant financial documents. This typically includes the income statement, balance sheet, and cash flow statement.
- Analyze operating cash flow—calculate cash generated from core business operations by examining revenues and operational expenses. This reveals how the day-to-day activities impact the company’s cash position.
- Review investment and financing activities—evaluate cash used in investments (like buying assets) and cash from financing (such as loans or issuing stock). This step assesses how investment and funding choices affect cash flow.
- Make necessary adjustments—adjust for non-cash transactions like depreciation and consider changes in working capital (like inventory and accounts receivable/payable). This provides a more accurate picture of the cash flow.
- Compare and make decisions—compare the cash flow across different periods to identify trends. Use this analysis to make informed decisions about the company’s financial strategies and future planning.
If that feels like too much work, consider using cash flow forecasting technology to automate these processes for you so you can make cash-flow informed decisions faster.
Cash flow analysis methodology
When you review a cash flow statement, first check the number at the bottom telling you the net cash movement for the period. If it’s a positive number, cash increased over the period and if it’s negative, then the business spent more than it received. For example, Google’s company, Alphabet Inc, reported a negative net cash flow for the period ending December 2021 of $5.2 billion. The company had positive cash flow from operating activities of $91.7 billion, but negative financing cash flow from investing activities of $35.5 billion and negative cash flow from financing activities of $61.4 billion.
Then you can do further analysis by reviewing the 3 sections above and seeing where the cash inflows and outflows occurred. It’s also helpful to look at trends over time across multiple statements, so you can identify areas of strength and opportunities for improvement.
If your operating cash flow is negative, then you can start to investigate areas of the business where you may potentially have a cash flow issue. Ideally, your cash from operating activities will always be positive so not only can the business remain solvent, but you can continue to grow operations.
How to do a cash flow forecast
A cash flow forecast will give you a view of your company’s upcoming cash requirements and therefore help manage liquidity. A simple cash flow forecast indicates where your cash balances will be at certain dates in the future. This information can assist you to decide when you need cash available and when you can take advantage of excess funds. A more comprehensive cash flow forecast will start with an opening balance and track what payments and receipts will occur from now until a future date.
Cash flow example
Sarah decides to start a new e-commerce business selling homemade products called Scentsational Gifts, so she creates a simple cashflow forecast for the first 6 months of operation. In the cash inflows section, she includes the one-off cash investment she will put in to start the business, plus the forecasted sales she expects to make each month.
In the cash outflows section, she includes the cost of equipment she needs to set up the business, plus an estimate of the monthly outgoings like materials and marketing costs for paid advertising. As you can see by the net cash flow, there’s a small cash inflow each month, except for March when there is a cash outflow of $2,800 thanks to a one-off expense. After taking into account the inflows and outflows each month, she expects the closing cash balance at the end of June will be $9,200.
In order to make the best business decisions possible, you need the right information at your fingertips. Cash flow affects every area of decision-making, from whether you need to chase outstanding debtors to whether you can afford to expand operations. This makes cash flow statements and forecasts vital tools for ensuring your business flourishes.
Editors note: This article was first published in December 2022 and has been updated for relevance.
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