Cash flow analysis: The key to a healthy company

in Money by Julie Bawden Davis
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Cash flow analysis

For a small business, having adequate cash is critical, allowing you to operate, expand and get credit. Keeping tabs on the amount of cash you have moving in and out of your company at all times is essential. To do this, it's necessary to perform a cash flow analysis. While it doesn't determine your company’s profitability, it does show its liquidity, and is a key indicator of the health of your company.

Elements of cash flow analysis

A cash flow analysis statement contains a list of incoming cash, such as the sale of company goods, services and assets and loans and lines of credit. The document also lists the results of outgoing cash, including operational expenses such as purchases and loan payments. It groups all financial activities, detailing the inflow and outflow of money, into three main sections:

1. Operational activities:

This section shows how much money the company received from business operations. It doesn't include investment income. This portion is calculated by taking the net income from the income statement and adding in one-time charges, depreciation expenses, accounts payable, deferred taxes and accounts receivable.

2. Investment activities:

This portion of the cash flow analysis statement adds and subtracts all money generated from or spent or lost on investments. Such activities include money made selling shares of stock to the public, dividend payments to shareholders and purchase of equipment and property.

3. Financing activities:

This part of the statement shows financing, including the inflow of loans received and the outflow of loan payments made.

Free cash flow

Analysis of a cash flow statement will indicate the presence or absence of free cash flow, which is the amount of cash a company has on hand after all expenses have been paid. The free cash flow amount is considered a more accurate reflection of a company’s financial health than the earnings statement, which, because of the addition of items such as depreciation, may not show a true picture of how much money a company has on hand.

Consistent negative free cash flow is an indication that your company may be spending too much or not bringing in sufficient cash to cover expenses. Free cash flow is the financial health indicator that investors will study closely.

Create a cash flow budget

A cash flow analysis is best used to create a cash flow budget, which enables you to project the cash and cash equivalents you expect to come into your business and the cash outlay you can expect to pay out. By analysing your cash flow statement, you will also identify periods when you tend to have cash flow deficits and those times when there tends to be free cash flow. This will help you better prepare for such times and make plans for borrowing and investing, depending on the availability of cash.

Predicting budgets isn't a guaranteed science, but monitoring the inflow and outflow of money can help you make wiser decisions. Using a cash flow analysis will help you keep your financials on track and prepare for the future.

Find this helpful? You might also like:

How to forecast business cash flow

This post originally appeared on OPEN Forum, an online community providing small business owners with information and advice to help them do more business.

This article represents the views of the author only and not those of American Express.

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Julie Bawden Davis

A freelancer since 1985, Julie Bawden-Davis has written for many publications, including Entrepreneur, Better Homes & Gardens and Family Circle.

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