Everything you need to know about cash flow analysis

For many small business owners, financial statements can be intimidating. Balance sheets, income statements, and cash flow statements may seem overwhelming at first, but they don’t have to be. The more time you spend with them, the more you will understand them.

And that’s important because having a good understanding of your company’s financial statements can be extremely helpful both in better managing your business operations and in planning for growth. Financial analysis can help you understand things like the financial health of your business, which business activities are working, the accuracy of your forecasts, and more.

Other financial statements you’ll want to review include your balance sheet and income statement.

Cash Flow Analysis Formula

A cash flow statement, sometimes called a cash flow statement, is particularly important because it helps you understand how cash and cash equivalents have changed in your business throughout the year (or period). specific accountant) and your final cash position. Cash equivalents can be quickly converted into cash, usually within three months.

In its most basic method, cash flow statement analysis compares cash received to cash paid. Cash received includes sales revenue as well as investment or interest income. Money paid can include any number of items including inventory, taxes, payroll, loan repayments, etc.

Taking a simple approach can be helpful. But if you really want to understand your business’ cash flow, you’ll find there are more detailed ways to analyze it.

Operating cash flow can help you determine if your business has enough cash flow to maintain operations, without having to seek financing or additional financing. There are two ways to calculate operating cash flow: the direct method and the indirect method.

The direct method is used by companies using cash accounting. Here, cash inflows and outflows are all that is measured.

The indirect method is used by companies that use accrual accounting and includes non-monetary transactions as well as cash transactions.

You can also analyze free cash flow, which indicates the cash available to the business after paying operating expenses and capital expenditures.

Note that whatever method you use, you need to start with good data. This means that you need your accounts which are up to date.

What if you haven’t started your business yet? A cash flow statement can help you plan the expected cash flow for your business. In fact, your cash flow statement can be a key part of planning for a successful business, even if you have to make some educated guesses.

Cash flow statement

There are generally four main components in a cash flow statement:

  • Cash flow from operating activities
  • Cash flow from financing activities
  • Cash flow from investing activities
  • Net change in cash balance

These categories each contain important sets of information.

Cash flow from operations includes net income, depreciation, amortization, changes in accounts receivable, changes in accounts payable, taxes payable, changes in inventory, wages and similar items.

Fundraising activities include those used to fund your business. This may include notes payable, lines of credit, long-term debt and short-term debt. Payments on a small business loan or repayment of a business credit card would be included in this section.

The third main category, investing activities, includes capital expenditures, payment of dividends and other activities of a similar nature.

Relevant numbers in each section allow you to see which ones had positive or negative cash flow. These sections are then totaled so that you can quickly determine the net cash flow of all activities over a given period.

How Lenders Use Cash Flow Analysis

Lenders can use cash flow statements to quickly assess the liquidity (cash) of the business. A positive cash flow can indicate a financially healthy business. It also helps lenders understand the amount of debt a business may be able to handle.

Uncover opportunities with cash flow analysis

The opportunities go both ways when it comes to looking at cash flow analysis. A positive cash flow is generally a positive sign. This shows you that you have more money coming in than money going out, which, at a glance, is a good thing. However, you can still improve to expand your business, pay off debts, or upgrade your equipment. If you just focused on maintaining positive cash flow, you may not have taken advantage of these opportunities.

Negative cash flow may be as simple as it sounds – negative – but sometimes it is indicative of growth. While negative cash flow can certainly indicate that a business is struggling financially, is not profitable, or has overstretched itself, it can also accompany a period of growth. It may indicate that a business is hiring more employees, investing in equipment, inventory, or advertising, for example.

Ultimately, determining that a company’s cash flow is negative or even positive should not be the beginning or the end of a business health assessment. Rather, the statement as a whole should be reviewed and should be a starting point for understanding the career path.

Optimize your cash flow for business loans

While it may be normal for a business to experience negative cash flow for a period of time, be aware that it may hamper your ability to obtain a small business loan or financing.

Some lenders may be willing to lend if your business has strong revenue and the ability to make payments on a future loan. Many lenders will want to review three to six months of business bank statements.

You may have more financing options if you have good credit (personal and/or business credit) and are willing to provide a personal guarantee. The warranty can also be useful.

Ideally, however, you want to try to plan ahead. Although you may not feel like you need financing when you have a good amount of money in your business bank account, this may be the best time to ask for a margin of credit or other types of financing you expect to need in the future. It’s best to apply for small business financing before you desperately need money for working capital.

This article was originally written on July 29, 2022.

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