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Understanding Cash Flow Analysis

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Last editedJul 20213 min read

Along with the balance sheet and income statement, the cash flow statement is one of the most important financial statements your company prepares. Tracking cash inflows and outflows gives you a snapshot of your company’s standing at any given point in time. With cash flow analysis, you can gain an even deeper understanding of working capital – and whether you’re using it effectively.

Understanding the cash flow financial statement

Preparing a cash flow financial statement is one of the basics of business accounting. Its complexity will depend on your typical business practices and industry. Some will fit the entirety of an accounting period’s activity on a single page, while others will involve numerous appendices and schedules. What all cash flow statements have in common is that they list the movement of cash both in and out of your business.

Money coming into your business through accounts receivable are cash inflows, and money flowing out of your business through accounts payable are cash outflows. The cash flow financial statement offers an orderly list of all of these inflows and outflows, with a net cash flow as the balance. The net cash flow might be positive or negative, depending on your current financial standing.

What is cash flow analysis?

Now that you know the purpose of the cash flow statement, what is cash flow analysis? It’s a process that can involve looking at both current and future cash flows. Cash flow projections allow you to create a more accurate budget, forecasting the future withdrawals and deposits to your business accounts.

However, cash flow statement analysis doesn’t just look at the amount of money flowing in and out of your business, but also at timing. A thorough cash flow graph analysis will look at incomings and outgoings both month-to-month as well as over the course of a full year.

Why is cash flow statement analysis important?

Taking the time to prepare and analyze your cash flow statement helps ensure you have enough cash on hand to sustain business operations without going into debt. You need to have adequate cash inflows to cover all your outgoings. By applying cash flow budgeting methods, you can ensure that you have enough funds on hand for future periods of growth. You can also identify periods when your cash flow tends to be negative and find new ways to manage these deficits.

How to perform a cash flow analysis

It’s recommended to conduct your cash flow analysis once a month as minimum, but you might need to look at the cash flow statement on a more frequent basis depending on your industry.

Step 1: Prepare the cash flow statement using accounting software or a template. Input the starting cash balance, all cash inflows, and all cash outflows. Inflows and outflows are typically divided into three categories on the cash flow financial statement:

  • Operating activities – all expenses and money received from daily operations

  • Investment activities – purchase or sale of assets

  • Financing activities – Loan payments, dividends, and other items related to financing

Inflows should be marked with a positive and outflows with a negative. After recording all transactions for the accounting period in question, tally it up to calculate your closing balance.

Step 2: Determine whether your cash flow is positive or negative. You can do this by simply looking at the cash flow graph or statement you’ve just prepared. If the closing balance is greater than the opening balance, cash flow is positive. If it’s lower than the opening balance, cash flow is negative.

Step 3: Analyze transactions for clarity. Now that you know whether your cash flow is positive or negative, the next step in your analysis is to look at your statement, line by line, to understand where your money’s coming and going. Is there a high level of late payments from clients? Do you owe a significant amount of money to your own creditors? Is this month’s cash flow statement influenced by a large machinery purchase?

Step 4: Look for patterns. By taking the time to analyze your cash flows regularly, you’ll start to see patterns emerge. There might be a certain supplier that’s always late with a payment, or a slow period in the supply chain when you have to wait for new materials to arrive.

Step 5: Adjust your business operations. Once you’ve identified these patterns, it’s time to put your cash flow analysis to work. Here are a few simple ways to adjust your operations, investment, and financing for a positive cash flow:

  • Adjust payment terms for vendors

  • Adjust staffing requirements during slower periods

  • Purchase less inventory at certain times of the year

  • Adjust your pricing strategy

  • Increase your sales and marketing strategy

  • Find new sources of working capital

Although it might sound difficult to get started with a cash flow analysis, making it regular practice ensures that your business runs more smoothly over time.

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