Understanding Cash Flow Analysis

Keeping track of your cash flow is essential to the overall health of your business. Here's a quick look at understanding cash flow analysis

By Jade Jordan

A cash flow statement is mandatory for financial reporting as it sets out the amount of cash and cash equivalents that flow through a business. Ensuring your capital balance is running smoothly is essential to your business’s health. Here's a quick look at cash flow analysis.

Cash flow statement structures

A cash flow statement accompanies your balance sheet and income statement. The cash flow statement should show where money enters your business and how it is used.

Your cash flow statement shouldn’t look at any future income or outgoings. It should focus solely on your cash flow between a select past period. The structure should mean that you assess your three main sectors of cash flow, such as your core operations, investing, and financing.

Core operations

The core operation section of your statement should reveal the amount of revenue generated by your business. Adjustments are made to the net income within the income statement to reflect working capital changes. These may be things such as receivables, payables, and inventories.

You can calculate your core operations by either the direct or indirect method.

The direct method takes data from the income statement using cash receipts and cash disbursements related to operating activities. The net value of the cash receipts and cash disbursements equals the operating cash flow.
The indirect method converts the net income to operating cash flow by adjusting items that contribute to the net income calculations. It’s also important to mention they should not affect depreciation and amortisation.

Investing

This section of your cash flow analysis includes changes in equipment, assets or investments. It's often documented as cash spend when cash is used to purchase or replace a piece of equipment. However, you can also see ‘cash in’ caused by investing when a company divests itself of an asset in return for cash.

Financing

The financing and final section of the cash flow analysis relates to finance-driven changes to the cash flow. These could be any changes to debt, loans or dividends, such as the instance where capital is raised and cash enters the company. It could also be when dividends are paid out, and cash leaves the company.

Unless a company is engaged in raising new financing, it’s usually expected to see a net cash outflow within this section. However, when a company is expanding and raising new capital, you usually see a net cash inflow within this section.

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Gaining insights from your cash flow statement

The main purpose of examining a company’s cash flow is to ensure that revenue is keeping pace with profits. If your business is making sales but is struggling to get its bills paid, you’ll see declining net cash flows. If your net cash inflow starts lagging behind the net profit figure consistently, you might need to reassess.

In particular, look out for:

If the cash from operating activities is continuously larger than your net income, the net income (or revenue) will be labelled ‘high quality’. However, if your net income is larger than the cash from operating activities, further analysis will need conducting to reveal why the reported net income is not transferring into cash.

If your business is consistently generating more cash than it uses, you’re in a strong position to increase dividends. Here you can buy back stock, decrease debt and consider expanding as you are showing signs of good financial health.

Your cash flow statements can be used to predict future cash flows and budget. However, If there are considerable changes in cash flow from year to year, it’s important to understand why it happens. Only use your cash flow as a prediction method if you consistently show a steady pattern year on year.

If your cash flow is managed as part of a strategy, negative cash flow can be a sign of positive growth. If your business is expanding, you’ll naturally expect a decline in cash flow, but this should increase cash flow further in due course.

About the author

Jade Jordan works for Total Processing, a payment solutions provider for eCommerce sites. Their payment gateway solution comes complete with a fraud protection suite to augment security and protect your business.