If you don’t know how to do a cash flow analysis, you’re not making the right decisions for your business. Accounting teams will conduct an analysis of cash flow to better understand a company’s:
- Cash position
- Financial needs
But before we go any further, let’s answer an important question: what is analyzing cash flow anyway?
Let’s find out.
What is cash flow analysis?
Cash flow is the sum of all cash minus the sum of all outflows. When you deduct the outflows from the inflows, you can better understand how much money your business has to operate.
However, when discussing analysis, we’re doing a few things:
- Breaking cash into three categories:
- Cash from operating activities
- Cash from investing activities
- Cash from financing activities
- Analyze all three categories to see where cash is going in and out
For example, you may have solid cash from operating activities even though your cash flow is negative.
You may have more than enough cash coming in from sales to cover operating expenses, but you’re investing heavily in a new product or service. Tech companies often have this issue because they’re investing far more money than they own on opportunities.
The investment money may come from cash, but when it goes into negative territory, the investment money is coming from financing.
Financing, such as a massive loan or investment round, is still cash, and it’s counted as money in a cash flow statement. You have access to the cash from the loan and can use it for your business expenses, so the money can be counted in your statement.
When you conduct a cash flow analysis, you’re doing a few things:
- Learning how much money is coming in and going out from all three cash sources
- Gaining an understanding of how money is generated and lost during a specific span of time
- Understanding where cash is being used wisely and frivolously
- Generate unlevered and free cash flow reports
Newer businesses often struggle with cash flow and benefit the most from analysis because they’re spending a lot of money to make sales, gain market share and build their companies. Running a cash flow analysis provides insight into the true health of a business’s operations so that you know how healthy your cash flow is and what decisions you can make.
As your business grows, you may even start generating different types of cash flow statements, all of which shed light on your business’s operations.
Why is cash flow analysis important?
You’ve done a lot of work, created multiple cash flow statements and now want to justify a full analysis of your cash flow. Analyzing your cash flow is crucial because it:
- Helps new businesses get a firm grasp on their finances
- Provides insights into whether your business will be able to pay its bills
- Makes it easier to make sure that you can continue your operations
However, if you’re just using the data available for the three reasons above, you’re missing out on crucial information that you can and should extract from cash flow reports. Reverting to the three cash categories outlined earlier, we can then see how each category is impacting cash flow.
Perhaps you’re financing too much of your operations and can leverage your cash to pay off debt and cut back on financing.
Why would you do this?
Reducing the need for loans and credit means that you’re not paying out interest, are saving money and are in a better cash position in the long term.
The analysis goes beyond the basic information that a cash flow statement provides and allows you to really understand the cash inflows and outflows of your business. If you’re starting to understand the benefit of an in-depth cash flow analysis, you can now move on to analyzing your cash flow.
How do you perform cash flow analysis?
Cash flow analysis software is one of the best investments a business and accounting team can make because it makes the process faster, more efficient and error-free. You’ll also want to have a stakeholder, often an accounting team, run an analysis, but software can help you with creating:
- Cash flow statements
- Other financial statements
Next, a human can run the business cash flow analysis to fully understand how cash is being used in a business.
If you want to have a clear and concise understanding of your business’s cash inflows and outflows, an analysis is your best option.