Cash flow analysis uses cash flow; the cash or its equivalents generated or spent by a business over a stipulated amount of time. It determines the efficiency of the financial management of a business and its ability to pay bills and manage purchases for raw materials or finished goods. It may seem similar or equal to the profit earned by the company.
Here is an in-depth guide for Cash Flow Analysis.
What Is Cash Flow Analysis?
Cash Flow Analysis is a measure of regulating and analyzing the amount of cash flow in and the cash flow out over a stipulated period. Cash flow analysis involves a variety of activities like operating activities, finance activities, and investing operations i.e. a financial statement. These three form the primary three components of cash flow and lead to the number that defines the net cash flow.
It helps in financial planning and guides companies to prepare well after a specific interval of time or during situations like potential sales downfall or diverse economic conditions. A vast majority of businesses can handle negative cash flows for shorter periods, however, long-term negative cash flows can lead to bankruptcy or business failure. Some of the types include 'Levered Cash Flow' which determines cash flow keeping in mind the bills and commitment, whereas un-levered free cash flow determines cash flow before financial commitments.
Examining and evaluating cash flow may assist with economic strategizing and preparing for future events based on the size, goals, and liabilities of the organization.
Why Is Cash Flow Analysis Important?
Cash flow is an important determinant of finances and its management in companies and organizations. If a company is not able to track its expenses on inputs, expenses, purchases on assets, and make enough to maintain profits or break-even points, it might not be able to sustain itself.
Cash flow analysis calculates and considers the cash inflows and outflows of the company and defines the net cash flow measure (Current assets - Current liabilities).
There are two cash flow types determining where the cash arrives from and where it is spent. Positive cash flow states that the company is heading in the path of profits, generates enough cash flow and has a strong foundation. On the other hand, the negative cash flow is indicative of the financial troubles and issues of a business and highlights potential bankruptcy.
The best way to conduct cash flow analysis is to track the Statement of Cash Flows and use the figures to determine the business growth. Some crucial indicators in the analysis include free cash flow, comprehensive free cash flow coverage, sales ratio, and operational ratios. Such mechanisms are the driving force for the internal structure of the business.
How to Perform Cash Flow Analysis?
Conducting a cash flow analysis requires the illustration of the business structure and its working, and devising a cash flow statement for reference. To conduct a cash flow analysis, one must consider the investing, financing, and operating cash flow statements.
There is accounting software to develop cash flow analysis to input the data in sequential order for future reference. Such software with a centralized database and data interface or free templates on cash flow allows businesses to have an edge and a better grasp of the system.
The business can use it to uplift decision-making and get out of bankruptcy or allocate resources to drive more revenue.
Preparing Cash Flow Statement
The cash flow statement includes items like cash received in goods or service sales, payment of loans, financial activities between the company and stakeholders, inventory or supplies, wages and bonuses, contractors payments, utility bills, rent or lease payments, interests paid on loans, and other components.
Operating Cash Flow
To calculate net income, the Cash Flow Statement Direct Method subtracts cash collections from operational activities, whereas the Cash Flow Statement Indirect Method adds or subtracts non-cash revenue and expense components.
The operating activities component of a cash flow statement is calculated and prepared using two methods: the Cash Flow Statement Direct Method and the Cash Flow Statement Indirect Method.
Direct and indirect cash flow methods allow cash flow analysis to be carried out efficiently. Here is how the direct cash flow methods differ from indirect cash flow in preparing a Cash flow statement.
| Conditions | Cash Flow Direct Method | Cash Flow Indirect Method |
|---|---|---|
| Meaning | Uses net income as a foundation and adds non-cash expenses, deduct non-cash incomes like profits made and net adjustments between current assets and liabilities. | Involves only cash transactions, i.e. cash arrived and spent to achieve flow statement. |
| Mechanism | Reconciliation occurs to separate cash flow from others. | Net income is converted into cash flow. |
| Use Case | They are comparatively used in lesser industries. | Predominantly used by large companies. |
| Preparation Required | There is no need for preparations. | Net income conversion into a cash flow statement requires preparation, time, and effort. |
Investing Cash Flow
The outcome of investing cash flow is computed by deducting the money spent to purchase assets, stocks, or outstanding loans.
Financing Cash Flow
Cash flows between corporations, and the creditors, owners, and investors are used to calculate financing cash flow.
Cash Flow Analysis Example
Cash flow analysis must include general information like business income, revenue, and expenses. Consider a company with a net income at the beginning, of Rs. 80,000 and an extra cash flow worth Rs. 60,000, if the cash flow like salary payment and rent is Rs. 30,000, the overall cash balance comes to Rs. 110,000. Add to that -
- The factors like taxes and salary to hired individuals add to the line of items affecting the company.
- Make a company balance sheet elaborating on the cash income from accounts receivable, loans, and sales and determine the total cash flow.
- Add the total cash flow to starting net income to find the total cash available. Find the cash outflows or expenses on marketing, fee, insurance, rent, taxes, and payroll, and determine the total cash outflow.
- Subtract cash expenses from available cash to find out the ending cash balance and use it for cash flow analysis.
Steps to Cash Flow Analysis
Financial modeling is critical for managing cash inflows and outflows to ensure that there is adequate money to function and grow. There are certain things to consider if you are looking to make the best use of cash flow analysis. Take a look at the steps to follow for cash flow analysis.
Aim for Positive Cash Flow
The ratio of operating income to net income demonstrates a company's ability to grow. A high operating income indicates that the business is capable of surviving and can sustain its growth.
Evaluate Positive Cash Flow
The source of positive cash flow must be taken into consideration. A positive investing cash flow is a green indicator but a negative operating cash flow can suggest a problem, and a solution such as the sale of assets to cover expenses for operations.
Determine the Status of Negative Cash flow
Negative cash flow can suggest that a company is investing in equipment and raw materials and property to increase inventory.
Find out the Free Cash Flow
The sum left after paying operating and capital expenses is referred to as free cash flow. It can be used to repay principal and interest, purchase assets, or repurchase stock.
Calculate Operating Cash Flow Margin
The operating cash flow ratio determines the cash generated from operating activities following the sales revenue at a given time. A positive cash-from-operations margin shows productivity, profitability, and high-quality earnings.
Analyze Cash Flow With Software
Analyzing cash flow with software simplifies the task at hand. It reduces the possibility of human error and saves the company time and energy. Take a look at the key takeaways you may receive after using software -
- Effective cash flow analysis can be handled by bookkeeping or accounting software, often part of a broader enterprise resource planning (ERP) system.
- Large corporations employ teams of financial planning and analysis (FP&A) professionals who study market trends, look for financial patterns, and drive valuable results.
- ERP improves outcomes via instance and real-time reports, machine learning and AI-driven evaluation, and comprehensive financial analysis tools.
- With regular check-ins, both SMEs and large organizations can have a better outlook on cash flow and handle their business operations.
Simplifying Cash Flow Analysis With TranZact
Cash flow analysis is an important step for small, medium, and large-scale businesses. Use software, online systems, and free templates to find what works best for your business. TranZact offers smart inventory and accounting dashboards with visual data representation to support cash flow analysis and better financial decisions. You can access all your operational data in real time and make strategic and financial decisions with greater transparency and control!
FAQs on Cash Flow Analysis
1. What is the purpose of cash flow analysis?
Understanding where the money is coming from and where it is going is essential for maintaining a financially viable firm. It allows companies to detect loopholes faster and take immediate corrective measures.
2. How to analyze cash flow?
Cash flow is calculated by adding current assets and subtracting current liabilities, which can then be used to calculate ratios for further in-depth study.
3. How to calculate cash flow analysis?
Operating cash flow is calculated as follows: Operating cash flow = operating income + non-cash expenses - taxes + changes in working capital.
4. How do you perform a cash flow analysis?
To perform cash flow analysis, you need to first identify the sources of income, revenue, and expenses of the business and then create a cash flow statement and then analyze it.
5. What is the difference between cash flow and fund flow analysis?
Cash flow analysis is concerned with the actual movement of cash in and out of a company, while fund flow analysis is concerned with the movement of funds (cash and non-cash) within a company.
