As a business owner or manager, it is essential to understand the basics of cash flow analysis. When done properly, cash flow analysis can benefit a business in many ways, helping better understand how money moves in and out and giving the insight an owner needs to make informed decisions.
This article will quickly explore the basics of cash flow analysis, including what it is, why it is important, and how to use it to improve your business.
What is cash flow analysis?
Cash flow analysis involves looking at the total amount of money coming into a business from sales, investments, loans, or other sources and the total amount spent on operational expenses, taxes, and capital expenditures. It’s a vital tool for business owners and investors to understand the profitability of their investments and operations. It helps them gauge the rate of return on their investments, identify potential cash flow problems before they occur, and drive informed decisions on finance management.
Cash flow analysis helps to identify areas of cash that are not being used as effectively as possible and also to analyze trends in income and expenses. By understanding their cash flow position, business owners can make better decisions regarding investments, financing products, expansion plans, and more.
A strategic approach to analyzing cash flow can help businesses plan ahead and ensure having enough cash available when needed. Poor cash management practices may result in unexpected financial difficulties that could affect its ability to continue operations. That’s why cash flow analysis is necessary to manage a business efficiently.
Why is cash flow analysis important?
Cash flow analysis is essential for grasping how much money a company makes or spends during an accounting cycle. Being aware of the sources of cash and where it is being allocated is necessary for running a profitable business. At this point, cash flow analysis answers these and other critical questions about a business’s financial health and profitability.
Cash flow analysis can benefit the business in many ways.
It gives quantitative measures of a business’s profitability, such as amounts of earned and spent cash during a control period, allowing one to see how well they can fulfill their financial obligations and evaluate their current financial situation.
Cash flow analysis is an accurate and reliable method of business evaluation, which is hard to falsify, as it uses the company’s accounting records.
It helps finance consultants calculate and forecast the amount of cash a business might receive in the future based on the historical records of a company’s revenues and expenses. This way, cash flow analysis allows for more accurate short and long-term financial planning.
Cash flow analysis provides detailed breakdowns of all the company’s expenses, showing even those that might not appear in other financial statements.
Cash flow analysis can help identify the existing and potential bottlenecks in your cash flows, highlighting what processes to rethink to enable more cash to come in (for example, invoicing or inventory management, etc.). It also helps evaluate the financial results of changing strategies.
Cash flow analysis helps understand a company’s working capital – the liquid assets, like the cash the business has in hand to run its daily operations – being a valuable insight for investors.
How to perform cash flow analysis
To perform cash flow analysis, you need your company’s records of the inflows and outflows of money. Usually, you can track those using a cash flow statement.
The cash flow statement tracks the movement of money into and out of your business, breaking it into three important sections, such as cash flow from operations, cash flow from investing activities, and cash flow from financing activities. Often, there’s one more section showing the cash flow ending balance.
The cash flow from the operating activities section tracks the money that comes into your business through day-to-day operations. It includes sales, profit, interest and dividends, and other inflows from operations.
The cash flow from investing activities section tracks the money spent on investment assets, including purchases of equipment, buildings, and other assets. This section also displays money spent on investment loans and investment repayments.
The cash flow from the financing activities section tracks the money paid out for financing activities, such as loans or debt repayments.
The cash flow ending balance section tracks the amount of money left over in your business at the end of the period, which is the money that can be used to fund future cash flow needs.
Cash flow analysis allows you to assess your current financial position, forecast your future cash flow, and make informed decisions about how to use the money currently available to your business. It allows you to identify potential problems and opportunities, giving you time to take action to solve the first and capitalize on the latter. Besides, it helps you set appropriate budgets for future spending by forecasting how much money will be available. Long story short, cash flow analysis is a valuable tool helping assess business performance and predict future success or prevent failure.