How to Conduct a Cash Flow Analysis?

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Inadequate cash flow is the number one reason why small businesses fail. Your business may appear to be profitable, but if you’re strapped for cash, you won’t be able to pay your bills and keep operations moving.

Performing a cash flow analysis regularly can help you avoid cash shortfalls that can jeopardize your business. Let’s take a closer look at how to conduct a cash flow analysis and why it’s important.

Using A Cash Flow Analysis Is Crucial

The analysis of cash flow is crucial to the financial health of your business. An analysis will determine your company’s cash inflows and outflows from its operational, investment and financing activities.

Ultimately, this information will help you gauge the financial health of your business.

But what is cash flow analysis?

A cash flow analysis looks at the difference between how much cash you have at the beginning of the quarter or year and at the end of the period. It looks at your cash inflows and outflows from all sources.

Cash inflows include:

  •       Accounts receivable or credit account payments
  •       Sales of assets
  •       Income from investments
  •       Loan proceeds
  •       Funding from investors
  •       Proceeds from grants or awards
  •       Sales of goods and/or services

Cash outflows include:

  •       Accounts payable
  •       Debt payments
  •       Operating expenses
  •       Purchase of assets

Now that you understand what a cash flow analysis is, we can look at the importance of cash flow statement analysis.

The reason why a cash flow statement analysis is so important is that it shows changes in your cash flow position. A business can be profitable on paper and still be cash poor. A cash-strapped business is at risk of going out of business.

Performing a cash flow analysis will help you avoid shortfalls that can jeopardize your company.

Flow of Cash Statement

To perform an analysis, you first need to create a statement of cash flows. Your statement of cash flows looks at the changes in your balance sheet and income statement during the most recent period.

Statements of cash flow can be prepared using the direct or indirect method. Regardless of which method you use, a statement of cash flow will include the following:

Flows of Cash from Operating

Operations cash flow will look at the accounts on your balance sheet and income statement so that you can see the difference between last year and this year.

It includes the cash inflows and outflows from your daily operations. For example:

  •       Net income
  •       Depreciation
  •       Inventory increases
  •       Accounts receivable
  •       Accounts payable
  •       Loans payable

Income from Investments

A statement of cash flow will also look at your business’s investment activities. Investment activities can include an increase in new equipment, property or traditional investments.

Flows of Cash from Financing

Additionally, your statement will look at your financing activities. Financing activities include your long-term debt as well as equity accounts.

Methods for Examining the Cash Flow Statement

There are many ways to examine your working capital and cash flow analysis. Here are a few important things to look for:

  •       Deficit patterns. Maybe you seem to run into a deficit at the same time every year, and that deficit is getting bigger every year. In this case, there is likely an underlying issue that needs to be addressed. You may need to adjust your business model or make other changes to prevent future shortfalls.
  •       Negative ending balances. If you have a negative balance at the end of any given month, take a closer look at what’s going on. Consider the timing of your inflows and outflows and see if you can make adjustments to delay expenses. Keep in mind that it may be normal to have a negative balance in your investing activities section.

Cash flow management and forecasting tools can also help you create statements that are easy to analyze, and they often integrate with your accounting tools. For example, Cash Flow Frog integrations include QuickBooks, Xero, FreshBooks and more.

The Bottom Line

Cash flow analysis can help you gauge the financial health of your business and whether you need to make any changes to prevent cash shortfalls in the future. Use the tips above to learn how to create a cash flow statement and perform an analysis. With this information in-hand, you can make smarter business decisions and help your business grow.

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