Utilizing a Cash Flow Analysis for Your Small Business

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If you want to know where your business stands financially, you can find out through the utilization of a cash flow analysis. Now, you may be asking yourself “What is a cash flow analysis?” It’s actually a rather simple concept. A cash flow analysis helps you determine cash inflow vs. outflow, which is vital for any business looking to stay operational. A business’s cash flow is its lifeblood. Despite this, many small businesses still struggle with managing their cash flow. Therefore, knowing how to make a cash flow statement produces more sustainable outcomes.

What is a Cash Flow Analysis?

To understand what a cash flow analysis is, you need to first define cash flow. Cash flow measures the amount of money that comes in and out of a business during a specific period. When you’re making more than you’re spending, you have a positive cash flow. This makes it possible for you to pay bills and cover other expenses. You cannot downplay the importance of performing a cash flow analysis because it tells you where your business stands.

In simple terms, a cash flow analysis allows you to review how your business generates income and spends money. It helps you calculate where your money goes and how much cash you have at any given time. Therefore, learning how to prepare and read a cash flow statement is vital to assess your business’s financial health.

The importance

cash flow statement

A cash flow analysis is a vital part of your business plan coming to fruition. By learning how to make a cash flow statement, you can easily track how much cash comes in and how much goes out. A cash flow analysis helps you know where your business stands. It also helps you predict if you will need any financing, now or in the future.

Therefore, when conducting a cash flow analysis, track how long it takes for clients to pay you back. Some lenders will let you use part of your accounts receivable as a form of collateral for asset-based loans. That’s why you need to know how to make a cash flow statement and analyze your cash inflow vs. outflow. Some lenders offer these loans against 80% of the eligible receivables, so you need to know precisely where you stand.

When performing a cash flow analysis, you will also need to plan for future cash crunches. For example, if you add the cost of operations to your initial cash and get a negative amount, you may need to secure a bridge loan to close that gap. In addition, you should also decide on the type of financing you’ll secure if your cash flow wanes. For instance, for a shortfall of just a few weeks, you may need to apply for a working capital loan.

On the other hand, if you’re falling short because of a buildup of inventory, required renovation, or a particularly high demand, a regular business term loan may be a better financing choice. Always keep a reserve in case of an emergency. You can do this by being careful not to max out a loan advance too fast. If you max out your loan, consider asking for an increase in your line of credit or refinancing for a higher credit limit.

Cash Inflow vs. Outflow

Cash inflow and outflow directly relate to your core business activities. To properly perform a cash flow analysis and keep track of your liquid funds, you need to really dig into the details. Carefully scrutinize your accounting activity, and note any changes in your transactions, as well as your inventory and tax payments. Understanding cash flow vs. outflow is the first step.

Your main goal here is to achieve a positive cash flow from your business’s operations. Unless you own a non-profit, one of the main goals of your business is to generate more than you spend. A few periods of a low or negative cash flow are normal. As long as you have a plan in place to increase accounts receivable and your inventory, you should be fine.

However, you still need to maintain a positive cash flow from operations to become a sustainable business. If you have a series of periods of negative cash flow from operations, you could find yourself in serious trouble.

How to Conduct a Cash Flow Analysis

When conducting a cash flow analysis, it’s important to keep tabs on your accounts receivable. If they continue to increase from one period to the next, make sure you have the proper billing and collection processes in place to support that. While sales and credit look good on paper, they may tell another story if your customers do not make their payments on time. In most cases, you can gather your revenue information from your merchant service provider if you accept non-cash payments.

Operations cash flow

Two forms of accounting may be used to analyze how cash moves in a business. Both accrual and cash accounting methods can be used in a cash flow analysis. Public companies normally use accrual accounting, which reports the revenue as income when it’s earned rather than paid.

Likewise, the company records expenses when they occur, even if they have not made any cash payments yet. Each sale represents an accounts receivable, and therefore has no impact on cash until a business collects the payment.

Cash accounting

Cash accounting covers payments recorded when they’re received. With cash accounting, the company also records expenses during the period they come in. Therefore, a business records both revenues and expenses upon either their receipt or payment.

When you analyze a cash flow statement, you need to know the difference between earnings and cash. Here, they are not the same thing. Earnings occur when a sale or expense happens. However, cash activity or cash inflows vs. cash outflows may happen at a later time. It’s important to understand the difference in these terms when you perform a cash flow analysis.

Pending payments

From an accounting viewpoint, a business may be profitable. However, if the account receivables become uncollected or past due, financial problems can erupt. Even if your company happens to be profitable, you may fail to properly analyze and manage your operations’ cash flow. That is why you need to know how to make and read a cash flow statement. Pending payments are often a problem when companies perform accrual accounting.

Equipment investment/rentals

Part of your cash flow assessment may be directed toward what you invest or rent in equipment. Normally, businesses choose to rent their equipment to free up their cash flow and reduce issues like the cost of updates.

If your business rents equipment, you can rent newer or nicer equipment than you could buy. Plus, you may need to have the latest equipment to support your company’s safety requirements. You can make this happen and keep your cash flow healthy if you choose to rent over buying. Equipment could be your credit card terminal, machinery, and more.

How to Make a Cash Flow Statement

cash inflow vs outflow

To make a cash flow statement, format the document so it shows three types of cash flow activities. These three types include operating cash flows, investing cash flows, and financing cash flows.

Let’s first look at the operating cash flows section.

The operating cash flows section of your cash flow statement covers the operational activities that produce business revenue. Therefore, the cash flows under this category include sales, purchase transactions, and other activities. These cash flows can be presented as direct or indirect.

The direct presentation

When a company directly presents operating cash flows, it highlights them on a list. This list includes transactions such as cash from sales, withdrawals for expenses, etc. Companies usually opt to present their operating cash flows by the indirect method. Businesses use this method by presenting operating cash flows as a sum of the company’s profits.

The indirect method

When presenting cash flows by the indirect method, there are no specific guidelines on what profit amount should be the starting point. Companies may use the operating profit, profit before tax, net income, or profit after tax. The precise starting point for the analysis determines what adjustments should be made to reach an accurate number.

Depreciation expense

Machinery and equipment depreciate over time, which costs businesses money. These depreciation expenses reduce a company’s profit but do not affect its cash flow. This is because it’s a non-cash expense. Therefore, the company adds this expense back on a cash flow analysis. To treat interest and tax cash flows as operating cash flows, subtract them from the starting point profit or sales projection for the year.

Investing cash flows

Cash flows from investments include the acquisition or disposal of assets and other investments that are considered non-current. These are investments that have not been included in cash equivalents. Therefore, these cash flows cover the buying and selling of property, plant, and equipment (PP&E) and similar non-current assets. The cash spent on buying PP&E is considered a capital expenditure.

Financing cash flows

Financing cash flows represent cash used for borrowing and repaying loans, issuing and buying shares of stock, and paying out dividends. These cash flows change the composition and size of equity capital. Include these in your cash flow analysis under the appropriate section.

Cash Flow Analysis: Final Thoughts

If you don’t understand the dynamics of a cash flow analysis, you could make an inaccurate calculation. This could lead to a shutdown in business operations sooner than you expected. As noted, the cash inflow vs. outflow for your business provides major insights into the business decision-making process.

Now that you know how to make a cash flow analysis, you can plan for cash crunches, buy inventory at the right time, and refinance a loan for working capital if you need to. In addition, by analyzing your business’s cash flow, you can stay on top of your business activities and readily meet your business’s financial obligations. Making a cash flow statement will help support the full scope of your business activities.