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What is Cash Flow Analysis?

  • Ayush Singh Rawat
  • Feb 02, 2022
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Cash flow is an important indicator of a company's financial health. You may find it difficult to pay your vendors and employees if you don't have a good cash flow. 


Understanding how to perform a cash flow analysis will assist you in avoiding these financial hazards. This article will lead you through the phases of the calculation as well as the advantages of doing so.



Cash Flow Analysis: An Overview


Cash flow analysis is a financial statement that records how money flows into and out of your business during a specific predetermined period of time. 


Companies should track and evaluate three forms of cash flow to establish their liquidity and solvency: cash flow from operating operations, cash flow from investment activities, and cash flow from financing activities. A company's cash flow statement includes all three.


Businesses do a cash flow analysis to understand where money is flowing in and leaving out by correlating line items in those three cash flow categories. They can make judgments about the present status of the firm based on this.


Bringing in money isn't always a positive thing, depending on the sort of financial flow. Furthermore, spending money isn't always a negative thing. (Here)


Importance of Cash Flow Statement


The way cash travels inside a company's financial accounts are determined by two types of accounting. There are two types of accounting: accrual accounting and cash accounting.


Most public firms employ accrual accounting, which is a technique of accounting in which revenue is recognised as income when it is earned rather than when the company gets paid. Even if no monetary payments have been made, expenses are recorded when they are incurred.


When a corporation makes a sale, for example, revenue is recorded on the income statement, but the company may not receive cash until later. The corporation would make a profit on the income statement and pay income taxes on it from an accounting viewpoint. However, no money would have changed hands.


Furthermore, the deal would almost certainly result in a cash outflow at first, since the firm would have to purchase inventories and create the goods to be sold. It's typical for firms to extend payment terms to customers of 30, 60, or even 90 days. The sale would be an account receivable, which would have no effect on cash until it was collected.


Payment revenues are documented during the period in which they are received, and costs are recorded during the period in which they are paid, according to cash accounting. In other words, when cash is collected and paid, revenues and costs are recorded.


Earnings and money are two separate concepts. Earnings occur in the present when a sale is made and a cost is incurred, but cash inflows and outflows can happen at any time. When it comes to managing company payments, it's critical to recognise the distinction.


On the income statement, a company's profit is reported as net income. The company's bottom line is its net income. However, due to accrual accounting, net income does not always imply that all receivables from consumers have been collected.


According to Investopedia, the firm may be prosperous in accounting terms, but if receivables go past due or uncollected, the company may face financial difficulties. Even prosperous businesses sometimes struggle to manage their cash flow, which is why analysts and investors need to know how to read a cash flow statement.


(Must read: Cost-benefit analysis)


How to Conduct a Cash Flow Analysis?


A cash flow analysis should be done at least once a month, but you can do it more frequently if necessary. If you work in a highly volatile business or have cash flow problems, you should do a cash flow analysis on a weekly or even daily basis. 


You may forecast your cash flow for as long as you like. A reasonable beginning point is four to six weeks.


How to Prepare a Cash Flow Statement


The creation of a cash flow statement is, of course, the first stage in a cash flow statement examination. If you utilize accounting software, you'll be able to simply construct cash flow statements using it.


Begin your cash flow statement by putting your company's entire cash balance at the start of the specified time period into your spreadsheet. (If you've already completed a cash flow statement, use the ending balance from the previous one. Take the cash balance from your balance sheet if this is your first time).


Then, under three categories: operational operations, investment activities, and finance activities, fill in the spaces by adding cash inflows (money coming in) and outflows (money going out). Inflows will be marked as positive (+) and outflows will be marked as negative (-).


  • Operating activities: Money collected from sales and paid receivables is included in operating inflows. Money paid to suppliers, employee wages, any taxes not tied to investment or financing, and depreciation or amortisation of corporate assets are all examples of operating outflows.

  • Investment activities: This refers to the acquisition or sale of non-operational assets such as company equipment, real estate, or stocks. Money spent on these products should be recorded as an outflow, while money earned by selling or renting them should be recorded as an inflow.

  • Financing activities: Financing operations include things like issuing stock to shareholders or buying it back, paying payments on a corporate loan, and distributing dividends. For example, if you took out a loan for your firm, the loan would be recorded as an inflow, but each payment you made would be recorded as an outflow.

Add everything up to arrive at the closing balance once you've recorded all of the essential transactions on your cash flow statement (the amount left at the end of the cash flow statement period). You have positive cash flow if the ending balance is higher than the initial balance. If it's less than that, you've got a cash flow problem.


(Also read: Equity Financing)


Advantages of Cash Flow Analysis


  1. Maintain Adequate Cash Reserves


Knowing when your customers' payments are due and when your bills are due allows you to determine if you'll have enough cash on hand to pay your debts.


If you book a  20,000 rupees sale that costs Rs.10,000 to fulfil, the transaction might affect you if you have to pay Rs.10,000 to your suppliers and workers within 30 days, but your client doesn't have to pay the Rs.20,000 bill for another 60 days. A cash flow analysis helps you to have enough cash on hand to deal with circumstances like these.


  1. Manage Credit Better


If you pay your expenses using a credit card, a cash flow analysis can help you plan ahead to ensure that you have enough credit or that you can get a loan in a timely manner. Build in a buffer for cost overruns, late payments, or bad debt in addition to calculating cash flow based on predicted costs and income. 


Mismanaging your credit may result in refused charges, interest penalties, fines, and harm to your credit record and score, in addition to an inability to pay your expenses.


  1. Helps You Adjust


Knowing your cash flow condition will allow you to make necessary modifications to keep your company running. If you're paying off debt each month, a cash flow analysis can tell you that you need to save that money for a quarter to grow your reserves. 


During a period of slow receivables, you may be able to cut costs in a certain area. You may be able to postpone your income in some cases, compensating yourself for what you didn't take when your earnings improve. To assist you to get through a short-term financial shortage, you may persuade consumers to pay sooner or arrange with creditors to postpone payments.


  1. Avoids Production Interruptions


Even if you have a lot of money on paper, you won't be able to keep your employees employed or your suppliers providing goods if you can't pay them on time. You may lose your capacity to make payroll, make deposits, or acquire supplies and materials if you are unable to create your product or deliver your service. 


Even a little halt in production may wreak havoc on your profitability and throw your budget out of whack. Furthermore, if you are unable to fulfil orders, rumours about your firm will spread, and your clients may seek a new provider.


(Suggested reading: What is a credit rating?)





Consider using tax software or hiring a professional accountant to double-check your strategy while you compile your cash flow statement. You might also take online courses or seek assistance from a business mentor through organisations such as SCORE or the Women's Business Development Center.


Above all, even if cash flow tracking is a new skill, don't be frightened to try it. Even if the analysis is flawed, it still delivers more knowledge than doing nothing at all. You'll feel more in charge of your company's finances as you improve your forecasting skills.

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