Understanding cash flow analysis

A cash flow analysis is crucial in assessing the liquidity and solvency of a business.

Key takeaways

  • Cash flow analysis involves examining three types of cash flow statements: cash flow from operating, investing and financing activities
  • A cash flow analysis can provide valuable insights into whether your business has sufficient cash to remain solvent and meet future capital and growth requirements

What is Cash Flow Analysis?

A cash flow analysis is crucial in assessing the liquidity and solvency of a business. It involves examining three types of cash flow statements that demonstrate, over a specified period, the inflow and outflow of cash in a business:

Cash Flow from Operating Activities

This statement reflects the cash generated from a company's core business operations, such as sales of goods or services, and cash spent on regular operating expenses like salaries, rent, and utilities. It indicates the company's ability to generate sufficient cash flow to cover its day-to-day operational costs.

Cash Flow from Investing Activities

This statement shows the cash inflows and outflows related to a company's long-term investments and assets, such as the purchase or sale of property, equipment, or investments in other companies' stocks or bonds. This statement helps to identify how much money a company is investing in assets that can potentially generate future growth and revenue.

Cash Flow from Financing Activities

This statement captures the cash inflows and outflows related to a company's funding sources, such as issuing or repaying loans, issuing or buying back equity, and paying dividends to shareholders. This statement provides insights into a company's financial structure and its ability to manage its financing needs.

Example of a Cash Flow Analysis

Let's imagine a company called "British Bakes" that specializes in baked goods. The company has recently experienced a surge in demand, and the owners are interested in understanding their cash flow to make informed decisions about expanding their business.

Using a cash flow analysis, they examine their cash flow statements for the past six months. They find the following data:

Operating Cash Flow

Cash received from sales: £50,000

Cash paid for supplies and wages: £30,000

Net operating cash flow: £20,000

Investing Cash Flow

Cash spent on new baking equipment: £10,000

Net investing cash flow: -£10,000

Financing Cash Flow

Cash received from a business loan: £15,000

Owner's withdrawal: £5,000

Net financing cash flow: £10,000

The analysis reveals a positive operating cash flow, which indicates that the business generates enough money from its operations to cover its expenses. The negative investing cash flow reflects the company's investment in new equipment to accommodate growth. Finally, the positive financing cash flow shows the company has received external funding to support its expansion plans.

Why is Cash Flow Analysis Essential?

By generating and analysing cash flow statements, a business can determine its working capital and monitor cash inflow and outflow, facilitating better cash management in the future. A cash flow analysis can provide valuable insights into whether your business has sufficient cash to remain solvent and meet future capital and growth requirements.

Regular cash flow analysis ensures that you are aware of any cash shortages, enabling adjustments to be made. If the analysis indicates a surplus of cash, decisions can be made about whether to invest or save for a future period when cash flow may be lower.

Key Aspects of Cash Flow Analysis

Aim for positive cash flow

A positive cash flow is a good sign of a company's ability to remain solvent and sustainably grow its operations. When operating income exceeds net income, this is an indication of a healthy cash flow.

Be cautious about positive cash flow

Positive cash flow should be analysed further to determine its source. If the primary source of cash is from investing activities and the operating cash flow is negative, this may be an indication that the situation is not sustainable. Borrowing to sustain operating expenses may not be the best decision.

Analyse your negative cash flow

Negative cash flow requires further analysis, as it's not always indicative of a problem. Why is it negative? Is it due to the purchase of new machinery or useful investments that will enable the company to be more profitable in the future? If the operating cash flow is positive and investing negative, the company may be generating substantial profits and using them to fuel future growth.

Calculate your free cash flow

Free cash flow is the amount remaining after paying for operating and capital expenditures. This can be used for investment and growth, making it an essential figure to calculate.

Determine the operating cash flow margin

The operating cash flow margin is calculated as cash from operating activities as a percentage of sales revenue in a given period. A positive margin indicates a company's profitability, efficiency, and future earning potential.

How to Perform a Cash Flow Analysis

To conduct a cash flow analysis, you must first prepare operating, investing, and financing cash flow statements. Typically, the finance team uses the company's accounting software to generate these statements. Alternatively, various free templates are available online.

When preparing a cash flow statement, consider the following line items:

  • Cash received from the sale of goods or services
  • Purchases of inventory or supplies
  • Employee wages and cash bonuses
  • Payments to contractors
  • Utility bills, rent, or lease payments
  • Interest paid on loans and other long-term debt and interest received on loans
  • Fines or cash settlements from lawsuits

In summary, cash flow analysis is an essential tool for managing your business's financial health. By regularly monitoring and evaluating cash flow statements, businesses can make informed decisions, ensure solvency, and plan for future growth. It's crucial to understand the different cash flow types and use this information to create a comprehensive financial strategy that supports your business's goals.

Have you thought about invoice finance as a cash flow finance solution?

Invoice finance allows you to release cash quickly from your unpaid invoices.

As your lender, we can release up to 90% of your invoices within 24 hours. On payment of the invoice from your customers, we will then release the final amount minus any fees and charges. There are different types of invoice financing options available such as factoring (mainly invoice factoring and debt factoring) and invoice discounting to businesses depending on the situation and the level of control they require in collecting unpaid invoices.

We are an invoice financing company who offer a solution whereby payments are collected on your behalf managed by our team of expert credit controllers so you can focus on running your business. Our confidential invoice discounting solution is offered to businesses who want to maintain their own credit control processes, therefore this remains strictly confidential so your customers are unaware of our involvement.

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The benefits of invoice finance companies such as Novuna Business cash flow

  • Boost your cash flow without having to wait up to 120 days for your customers to pay you

  • Release up to 90% of the invoice straight away, and the final 10% when the invoice is settled

  • Access funds within 24 hours from initial appointment with our revolutionary digital onboarding process

  • Benefit from our in-house credit control processes, allowing you to focus on running your business, instead of chasing clients for payment

  • Six month trial period followed by a rolling contract

Want to understand more Cash Flow Finance terms?

Our Cash Flow Resource Hub has been set up to help SME's with cash flow finance advice, tips and resources to help with their cash flow position.

We explore ways you can begin improving your cash flow situation and start getting your business on track to positive cash flow.

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