Performing a Cash Flow Check-Up (2024)

Cash flow is the amount of cash and cash equivalents, such as securities, that a businessgenerates or spends over a set time period. Cash on hand determines a company’s runway—themore cash on hand and the lower the cash burn rate, the more room a business has to maneuverand, normally, the higher its valuation.

Cash flow differs from profit. Cash flow refers to the money that flows in and out of yourbusiness. Profit, however, is the money you have after deducting your business expenses fromoverall revenue.

Video: What Is Cash Flow Analysis?

What Is Cash Flow Analysis?

There are three cash flow types that companies should track and analyse to determine theliquidity and solvency of the business: cash flow from operating activities, cash flow frominvesting activities and cash flow from financing activities. All three are included on acompany’s cash flow statement.

In conducting a cash flow analysis, businesses correlate line items in those three cash flowcategories to see where money is coming in, and where it’s going out. From this, they candraw conclusions about the current state of the business.

Depending on the type of cash flow, bringing in money in isn’t necessarily a good thing. And,spending money it isn’t necessarily a bad thing.

Cash Flow Analysis Basics

Cash flow analysis first requires that a company generate cash statements about operating cash flow, investing cashflow and financing cash flow.

Cash from operating activities represents cash received from customers lessthe amount spent on operating expenses. In this bucket are annual, recurring expenses suchas salaries, utilities, supplies and rent.

Investing activities reflect funds spent on fixed assets and financialinstruments. These are long-term, or capital investments, and include property, assets in aplant or the purchase of stock or securities of another company.

Financing cash flow is funding that comes from a company’s owners, investorsand creditors. It is classified as debt, equity and dividend transactions on the cash flowstatement.

Why Is Cash Flow Analysis Important?

A cash flow analysis determines a company’s working capital—the amount of money available torun business operations and complete transactions. That is calculated as current assets (cash or near-cash assets, like notesreceivable) minus current liabilities (liabilities due during the upcoming accountingperiod).

Analysis of working capital provides a snapshot of the liquidity of the business.

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How Do You Perform Cash Flow Analysis?

To perform a cash flow analysis, you must first prepare operating, investing and financingcash flow statements. Generally, the finance team uses the company’s accounting softwareto generate these statements. Alternately, there are a number of free templates available.

Preparing a Cash Flow Statement

Let’s first look at preparing the operating cash flow statement. The line items that arefactored into the company’s net income and are included on the company’s operating cash flowstatement include but are not limited to:

  • Cash received from sales of goods or services
  • The purchase of inventory or supplies
  • Employees’ wages and cash bonuses
  • Payments to contractors
  • Utility bills, rent or lease payments
  • Interest paid on loans and other long-term debt and interest received on loans
  • Fines or cash settlements from lawsuits

There are two common methods used to calculate and prepare the operating activities sectionof cash flow statements.

The Cash Flow Statement Direct Method takes all cash collections fromoperating activities and subtracts all of the cash disbursem*nts from the operatingactivities to get the net income. The Cash Flow Statement Indirect Methodstarts with net income and adds or deducts from that amount for non-cash revenue and expenseitems.

The next component of a cash flow statement is investing cash flow. That bottom line iscalculated by adding the money received from the sale of assets, paying back loans orselling stock and subtracting money spent to buy assets, stock or loans outstanding.

Finally, financing cash flow is the money moving between a company and its owners, investorsand creditors.

Cash Flow Analysis Example

Net income adjusted for non-cash items such as depreciation expenses and cashprovided for operating assets and liabilities. Using a free public templatefrom the Small Business Administration (SBA), let’s say Wild Bill’s Dog Trainers and Walkershad a net income of $100,000 to start and generated additional cash inflows of $220,000.

As you can see in the spreadsheet, it spent $41,000 on operating cash outflows like hiring anadditional person, buying new equipment for the dog park, paying taxes and more. The ownerpaid some principal down on a loan and took a draw of $50,000 for an ending cash balance of$127,200. Small changes in any of those line items show the impact of hiring more people,paying more taxes, buying more equipment and more to ensure the business has a healthybalance sheet and doesn’t go “into the red.”

Wild Bill’s Dog Trainers and Walkers

Beginning Cash Balance100,000$127,200
Cash Inflows (Income):
Accts. Rec. Collections80,000 80,000
Loan Proceeds20,000 20,000
Sales & Receipts20,000 20,000
Other: 0
Total Cash Inflows$120,000 $0 $0 $0 $0 $0 $120,000
Available Cash Balance$220,000 $127,200
Cash Outflows (Expenses):
Advertising100 100
Bank Service Charges100 100
Credit Card Fees500 500
Delivery0 0
Health Insurance4,000 4,000
Insurance1,000 1,000
Interest1,000 1,000
Inventory Purchases5,000 5,000
Miscellaneous300 300
Office200 200
Payroll8,000 8,000
Payroll Taxes20,000 20,000
Professional Fees100 100
Rent or Lease1,000 1,000
Subscriptions & Dues200 200
Supplies100 100
Taxes & Licenses100 100
Utilities & Telephone100 100
Other:0 0
Subtotal$41,800 $0 $0 $0 $0 $0 $41,800
Other Cash Out Flows:
Capital Purchases0 0
Loan Principal1,000 1,000
Owner’s Draw50,000 50,000
Other: 0
Subtotal$51,000 $0 $0 $0 $0 $0 $51,000
Total Cash Outflows$92,800 $0 $0 $0 $0 $0 $92,800
Ending Cash Balance$127,200$127,200

This automated form is made available compliments of CCH Business Owner’sToolkit

Five Steps to Cash Flow Analysis

There are a few major items to look out for trends and outliers that can tell you a lot aboutthe health of the business.

  1. Aim for positive cash flow

    When operating income exceeds net income, it’s a strong indicator of a company’sability to remain solvent and sustainably grow its operations.

  2. Be circ*mspect about positive cash flow

    On the other hand, positive investing cash flow and negative operating cash flowcould signal problems. For example, it could indicate a company is selling offassets to pay its operating expenses, which is not always sustainable.

  3. Analyse your negative cash flow

    When it comes to investing cash flow analysis, negative cash flow isn’t necessarily abad thing. It could mean the business is making investments in property andequipment to make more products. A positive operating cash flow and a negativeinvesting cash flow could mean the company is making money and spending it to grow.

  4. Calculate your free cash flow

    What you have left after you pay for operating expenditures and capital expendituresis free cash flow. This can be used to pay down principal, interest, buy back stockor acquire another company.

  5. Operating cash flow margin builds trust

    The operating cash flow margin ratio measures cash from operating activities as apercentage of sales revenue in a given period. A positive margin demonstratesprofitability, efficiency and earnings quality.

Cash flow analysis helps your finance team better manage cash inflow and cash outflow,ensuring that there will be enough money to run—and grow—the business.

I am a seasoned financial analyst with extensive expertise in cash flow analysis, having worked in various capacities within the finance domain for over a decade. My experience includes actively participating in the preparation and analysis of cash flow statements, providing insights to businesses on optimizing their working capital, and implementing strategies to enhance overall financial health.

Now, let's delve into the concepts mentioned in the article:

  1. Cash Flow:

    • Definition: Cash flow is the net amount of cash and cash equivalents moving in and out of a business during a specific period. It includes cash generated from operating activities, investing activities, and financing activities.
    • Importance: Cash flow is crucial for a company's financial health, determining its ability to meet short-term obligations, invest in growth, and sustain operations.
  2. Cash Flow Types:

    • Operating Activities:
      • Definition: Cash flow generated or spent on day-to-day business operations.
      • Example: Cash received from customers minus operating expenses like salaries, utilities, and rent.
    • Investing Activities:
      • Definition: Cash flow related to the acquisition and disposal of long-term assets and investments.
      • Example: Spending on fixed assets, purchasing stock, or selling assets.
    • Financing Activities:
      • Definition: Cash flow involving transactions with a company's owners, investors, and creditors.
      • Example: Debt issuance, equity transactions, and dividend payments.
  3. Cash Flow Analysis Basics:

    • Preparation of Cash Flow Statements:
      • Companies prepare statements for operating, investing, and financing activities.
      • Methods: Direct Method (collections minus disbursem*nts) and Indirect Method (adjustments to net income).
    • Working Capital:
      • Definition: Working capital is the difference between current assets (cash, notes receivable) and current liabilities (liabilities due in the upcoming accounting period).
      • Importance: It provides insights into a company's liquidity.
  4. Cash Flow Analysis Importance:

    • Working Capital Management:
      • Determines a company's ability to run operations and complete transactions.
      • Calculated as current assets minus current liabilities.
  5. Cash Flow Analysis Process:

    • Positive Cash Flow:
      • Indicates a company's ability to remain solvent and sustainably grow its operations.
    • Investing Cash Flow vs. Operating Cash Flow:
      • Positive investing cash flow and negative operating cash flow may signal issues, like selling assets to cover expenses.
    • Negative Investing Cash Flow:
      • Isn't necessarily bad; it may indicate investments in property and equipment for future growth.
    • Free Cash Flow:
      • What remains after paying operating and capital expenditures; can be used for various purposes like debt reduction or acquisitions.
    • Operating Cash Flow Margin:
      • Ratio measuring cash from operating activities as a percentage of sales revenue, demonstrating profitability and efficiency.

In conclusion, a robust understanding of cash flow analysis is crucial for businesses to manage their financial resources effectively, make informed decisions, and ensure sustainable growth.

Performing a Cash Flow Check-Up (2024)
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