If you’re not familiar with cash flow analysis, then it could be something that has a big impact on your business. Cash flow analysis gives you a better understanding of your company’s cash flow and overall business performance. You might think you have a successful business, but without insights into cash flow and profit you can’t be sure.
Businesses can be defined in so many ways, and cash flow analysis is simply a universally accepted way of measuring success. How much cash your business has and how much you can generate over a period of time are quantifiable measures of your success. It’s for this reason that small business owners need to be aware how much cash they are generating and how much is spent over a given period of time. Cash flow analysis is one of the best ways of doing this.
Why choose cash flow analysis?
One of the key reasons for choosing cash flow analysis is that it can be measured and compared. Because cash is tangible and can easily be counted or measured in units that everybody understands, it’s easy to use this variable to compare two or more businesses.
Cash is also used because it’s extremely difficult to fake or fraud. Unlike some other assets such as property or stock, there is no easy way to confuse the issue when it comes to cash. You can’t artificially increase its value to make your business look more successful than it is.
The other major benefit of cash is that it is universally accepted. Nobody needs to be convinced about the value of ten million pounds. Everybody knows what that means and how much value it has. And unlike some other assets, the value of this ten million will always be a constant, unlike some other assets such as intellectual property. Plus, everybody accepts cash, so it has a continuous value.
How to assess cash flow
The main way that a business assesses their cash flow is through a cash flow statement. This presents the inflow and outflow of cash over a given period of time. It is very important for carrying out your cash flow analysis and without it, it’s impossible to give an accurate idea of the company’s performance.
The income statement will give you details such as the amount of interest you will pay on a loan and your balance sheet will let you know how much you owe. However, the cash flow statement will tell you how much cash is actually consumed in these transactions.
Understanding your cash flow statement
The statement is divided into three major activities that all companies carry out. These are operations, investing and financing. Of these three, the information relating to operations is perhaps the most fundamental as it shows how much cash you are making from regular operations – the basic sales of goods and services. It begins with the net income reported on the income statement, adds on non-cash expenses and adjusts for changes to current liabilities. So, for example, a sale made on credit does not affect cash but would increase sales and the accounts receivable. This should be deducted from net income to show the actual cash from operations.
The bigger picture
It’s important that you try to look beyond the net increase or decrease, otherwise you might miss some of the important information that the cash flow statement can reveal. For example, understanding how much you are spending allows you to get a clearer picture of what your business is earning. You can also make assessments about whether these earnings are sustainable or if they are being influenced by external factors.
If your business is not generating enough cash, then it may well be in trouble. Raising money through equity is fine, but it’s not money that the business itself is earning and indicates that you may need to focus your efforts elsewhere.
As well as operations, you also need to assess the cash flow in investment activities. This is generated by the sale of any fixed assets but also includes investment-related activities such as plant, property and equipment. Cash from these kinds of investment are not related to day-to-day activity but can help to give a picture of the financial health of the overall business.
Cash flow from financing activities is all about cash flow that goes to and from third-party financial backers. It is usually comprised of proceeds, which is cash coming in, and loan payments, which is cash going out. It is also related to cash flow from equity such as share purchases and dividends.
You need to measure the cash flow from operations, investments and financial activity in order to have a really clear picture of the cash situation in your business.
We’re here to help
If you run a small business, then you know the importance of being up to date and on top of every aspect. It may not feel like a valuable way to spend your time when you are so busy taking care of everyday operations, but taking the time to conduct a cash flow analysis can give you a really clear picture of your overall business health.
If you’re growing your business or even considering going public at some point, then this is a metric that is of great importance. It is the major component used to evaluate pricing for the initial public offerings, and you will be expected to have accurate records of cash flows at various points. So, that’s another very good reason why a cash flow analysis could benefit your business in the long run.
The bottom line is that cash and profit insights tell you how well you are doing as a business. The facts don’t lie, and even though you may think the business is going well, without the numbers to back it up you may never know for sure.