Cash Flow Analysis

Irrespective of the size of a company, the management of cash flow is an integral part of running a business. Understanding how money is moving in and out of your business will help you make strategic decisions for your business. You will also understand the financial health of your business.

What is Cash Flow?

Cash flow is the movement of money in terms of income and expenditure of your business. Ideally, businesses should have a positive cash flow with more income than expenditure.

With a positive cash flow, you can settle your bills and then invest in the growth of your business. If you have a negative cash flow, you will need to have an alternative source of income as your expenditure will be more than the money that comes in.

Meaning of Cash Flow Analysis 

You can understand a company’s cash flow by looking at the numbers in the cash flow statement or CFS. The Cash flow statement shows a company’s income from its ongoing businesses, external investments, and expenditure that pay for business activities and investments. Cash flow analysis will evaluate the inflows and outflows from these activities. It examines how the company is generating its revenue, where this money is coming from, and its overall value.

Uses of Cash Flow Analysis

One way to measure whether your business is successful is through cash flow analysis. It can measure how much cash is generated and spent by a business during a certain period. Following are some of the uses of cash flow analysis.

• Maintain Adequate Cash Reserves: Knowing when your bills are due or getting payment from customers lets you know if you have enough cash on hand. A cash flow analysis can help you maintain enough cash reserves to cover these situations.

• Manage Credit Better: A cash flow analysis can help you prepare to keep adequate credit availability or even arrange for a loan.

• Helps You Adjust: Understanding your cash flows enables you to make necessary adjustments to keep your operations running. For instance, if you have to pay off debt every month, the analysis will alert you to save money to build more reserves for that quarter.

How is Cash Flow Calculated?

There are two methods to calculate cash flow.

Direct Cash Flow Method

The direct cash flow method adds all the cash payments and receipts such as payments to suppliers, receipts from customers, salaries, etc. These figures are also calculated using the beginning and ending balances of assets and liability accounts and by analysing net decrease and increase in accounts.

Indirect Cash Flow Method

Cash flow can also be determined using the indirect method by adjusting net income by adding or removing differences from non-cash transactions. Non-cash items appear on the balance sheet as changes in assets and liabilities.

To determine an appropriate cash inflow or outflow, a company’s accountant will identify the growth and reduction in asset and liability accounts that need to be brought back to or removed from the net income number.

A cash flow statement is important to predict the strength, profitability and long-term future. Based on these predictions, businesses can take strategic decisions regarding budgeting and make their business finances better.