Why Your Business Needs a Cash Flow Analysis

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Thursday, April 19, 2018

Cash flow can have a massive impact on your business's ability to act on its decisions and reach its target. So why should you implement analysis?

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Cash flow analysis is a key element of success for any business. As part of registering your income, you will need to report a Statement of Cash Flows that shows the company's cash position.

Cash flow is defined as the difference in cash available from your business account at the beginning of your accounting period compared to the end of it. This should include any investments, assets, and loans your company has, as well as operating expenses and employee expenses.

For small businesses especially, cash flow is a key indicator of how well the organization is performing. Having a good proportion of cash puts you in a much stronger position, allowing you to make better business decisions and pay your accounts on time.

Cash flow analysis

You should use the last two years of balance sheets and compare the differences to create an accurate Statement of Cash Flows. This is the foundation of any cash flow analysis but here are some other metrics you can measure to get a clearer picture of where your business stands:

Cash flow statements

Your cash flow statement should include cash from operations, investing, and financing to give your business a clear view of its overall performance.

Operations - This is any cash that the organization makes internally rather than money it gets from external sources like investments.

Investing - This normally generates cash outflows as your company is investing money externally, though there can be cash inflows if you're selling off assets or other items.

Financing - This constitutes any debt and equity transactions your business needs to fulfill. You will also need to record cash dividends that are paid to shareholders in this section.

Operating Cash Flow

This sum shows companies how much of each sale is cash and what percentage is spent before it comes into the account, for example, on staff wages. It's usually calculated by looking at net operating cash flow, net sales, and revenue from the income statement. This should give you a percentage of how much cash your company earns from each sale.

There's no clear figure you should aim for and it largely changes from one industry to the next, but it's important that you monitor it. As your sales increase, your operating cash flow should grow at a similar rate. Comparing your percentage to your nearest competitors will give you the best idea of whether you need to make adjustments.

Free Cash Flow

This calculation is one of the most important for the smaller businesses. It is defined as cash that a company has left after it pays for any capital expenditures and it's a strong indicator of how your company is performing.

For this figure, showing your business has a steady and consistent number is one of the best ways you can prove your company is performing predictably.

Why's it so important?

Cash flow analysis is an important metric because it is tangible and widely accepted; it's incredibly difficult to fake, unlike many other business calculations, such as asset valuation. Cash is accepted as being judged at store value so there's few places to hide for anyone trying to tweak their figures. This means it's a highly trusted metric.

For these reasons, using cash flow analysis to measure your business's performance, and its position when it comes to paying its debts or fulfilling its future plans, is a reliable way to get a clear view that encompasses all elements of your operations.

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