If you’re running a business, you already know how important it is to keep track of your company’s cash flow. It is not enough to look at a business’s profits alone.
Business cash flow analysis involves recording and evaluating all money flowing in and out of a company to determine its working capital, liquidity, and operational efficiency. By comparing cash flow and profits, you will get a business’s net cash flow.
So, how do you do a proper cash flow analysis, you ask? Understanding cash flow analysis starts with accurate cash flow statements to understand where a company is receiving and spending money.
If you’re still unsure about cash flow analysis, don’t worry. In this guide, we’ll walk you through how to do a cash flow analysis and provide an example of a cash flow analysis to make the process easy to understand.
What is a Cash Flow Analysis?
Cash flow analysis, especially in the context of corporate cash flow analytics, is a key part of accounting that tracks all incoming and outgoing cash to help businesses maintain financial health. Two main methods of accounting determine the way cash flow statements are executed. In cash accounting, payments are recorded as they are received and expenses as they are paid, as opposed to accrual accounting, which records revenue as it is earned rather than received.
For example, cash flow analysis in accrual accounting counts revenue on an income statement after a sale is made, even if the company only receives the actual payment at a later date. In cash accounting, on the other hand, a sale is only shown on a statement when the exchange of money takes place.
In accrual accounting, it can be hard to get an accurate read on a company’s net income or profitability because receivables might be recorded on income statements, but have not yet been received. This can spell financial trouble for a company if many people are late to pay or the company fails to collect multiple receivables.
How to do a Cash Flow Statement Analysis
The first step in any cash flow analysis example is learning how to create a precise and well-structured cash flow statement. To perform the cash flow statement analysis, start by choosing a period to analyze.
Many companies choose to do cash flow analysis once a month, but it may be helpful to do it more often. You can figure out what works best for your specific business needs.
The cash flow statement will start with the company’s total cash balance. Next, you want to determine all of the cash inflows and outflows during the allotted period of time. The cash flow statement can be divided into three main sections: operating activities, investing activities, and financing activities.
Operating Activities
Cash flow from a business’s regular business operations is the first section of any cash flow statement. Operating activities include accounts receivable and accounts payable, as well as income taxes, and any changes to assets and liabilities.
Investing Activities
The second section of the cash flow statement includes all of the cash flow connected to a company’s investments. Investing activities are the outflow of cash via the purchase of large assets like equipment, vehicles, property, or buildings. Investing activities also include the inflow of cash from selling any of these assets.
Understanding cash flow related to investing activities will help paint a picture of how a business is investing in itself. This is important information for potential investors in any company.
Financing Activities
No business cash flow analysis would be complete without a financial activity cash flow section in the statement. This section is where all debt and equity-related activity is recorded. For example, funds coming into a business from a loan and money going out to pay back debt are considered financing activities.
This section also includes cash flow related to the purchase and sale of stocks and bonds, and the distribution of cash to a company’s shareholders.
How to Analyze the Cash Flow Statement
Once you've totaled all inflows and outflows from operating, investing, and financing activities, you'll reach your closing balance — a core part of any business cash flow analysis. If the closing balance is higher than the starting balance, you have a positive cash flow, and if it is lower than the starting balance, you have a negative cash flow.
A positive cash flow is a sign that your business is going well and that things are going according to your business plans. However, keep in mind that profitability and cash flow are not the same thing. You will need to calculate your profit margins to analyze profitability.
If you have a negative cash flow, this isn’t necessarily a cause for concern, so long as it isn’t a recurring issue month after month. A negative cash flow could mean your company has put money towards investing in itself this month and will be back to positive next month.
Understanding how to do a cash flow analysis is a fundamental part of running any business. If you do not have a clear understanding of cash flow, not only will you be unsure of where you need improvements, but your business could be in trouble, and you might not know it until it is too late.
Relevant Article: EBITDA – A Key Financial Metric for Business Analysis.
