Cash Flow Analysis, manage your business cash flow in 10 steps

Cash flow analysis is a financial analysis technique used to evaluate a company’s cash inflows and outflows during a given period. It provides insight into a company’s financial health by measuring its ability to generate cash from its operations and investment activities.

To perform a cash flow analysis, the following steps should be taken:

1. Create a Cash Flow Forecast:

Develop a cash flow forecast that projects your expected cash inflows and outflows over a specific period, such as a month or a quarter. This forecast helps you anticipate any potential cash shortages or surpluses, allowing you to plan accordingly.

Example:

Month	Cash Inflows ($)	Cash Outflows ($)	Net Cash Flow ($)
January	10,000	8,000	2,000
February	12,000	10,500	1,500
March	15,000	11,000	4,000
Total	37,000	29,500	7,500

2. Monitor and Track Cash Flow Regularly:

Keep a close eye on your cash flow by monitoring and tracking it regularly. Review your cash flow statement, which outlines the inflows and outflows of cash during a specific period. This helps you identify patterns, trends, and any potential issues that may arise.

Example:

If your projected cash inflow for February was $12,000 but the actual inflow was only $10,000, investigate the reasons for the shortfall. It could be due to delayed payments from customers or changes in market conditions. Adjust your strategies accordingly to improve cash flow in the future.

3. Improve Receivables Management:

Streamline your accounts receivable process to ensure timely payments from customers. Send out invoices promptly, follow up on overdue payments, and consider offering incentives for early payments. Efficient receivables management reduces the risk of cash flow gaps caused by delayed payments.

Example:

If you have a customer with an outstanding invoice of $5,000, send them a polite reminder and offer a 5% discount if they make the payment within a week. This can incentivize faster payment and improve your cash flow.

4. Manage Payables:

Effectively manage your accounts payable by negotiating favorable payment terms with vendors and suppliers. Seek opportunities to extend payment terms without negatively impacting your relationships. However, it is essential to honor your payment obligations within the agreed-upon time frame.

Example:

If a supplier offers a 30-day payment term, consider negotiating for a 45-day term to give yourself more time to use available cash for other business needs. However, ensure that you honor your payment obligations within the agreed-upon timeframe.

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5. Control Inventory Levels:

Maintain optimal inventory levels to avoid tying up excessive cash in stock. Analyze demand patterns, implement just-in-time inventory practices, and regularly review your inventory to identify slow-moving or obsolete items. This ensures that your cash is not unnecessarily tied up in inventory.

Example:

If you notice that a particular product has been sitting in your inventory for an extended period, consider offering a discount or running a targeted marketing campaign to sell it quickly and free up cash.

6. Monitor and Reduce Expenses:

Regularly review your business expenses and identify areas where you can reduce costs without compromising the quality of your products or services. Negotiate better deals with suppliers, find more cost-effective alternatives, and eliminate unnecessary expenses.

Example:

Assess your subscription services and software licenses regularly. If you find that you’re not fully utilizing a particular service, consider canceling or downsizing the subscription to save on expenses.

7. Establish a Cash Reserve:

Create a cash reserve to serve as a safety net for unexpected expenses or periods of reduced cash flow. Set aside a portion of your profits each month or quarter and designate it as a cash reserve to ensure you have funds available for emergencies or unforeseen circumstances.

Example:

Allocate 10% of your monthly profits to a designated cash reserve account. If your monthly profit is $10,000, transfer $1,000 to the cash reserve account to build up your emergency funds.

8. Consider Financing Options:

Explore financing options such as lines of credit, business loans, or invoice financing to bridge temporary cash flow gaps. However, exercise caution when using debt and ensure that the financing terms are favorable and align with your cash flow needs.

When managing your cash flow, consider different financing options that can provide additional liquidity during periods of cash flow gaps. Here are a few examples:

a) Line of Credit: Apply for a line of credit with a bank or financial institution. This allows you to borrow funds up to a predetermined credit limit when needed, providing temporary cash flow support.

b) Business Loan: Explore business loan options from banks or alternative lenders. These loans can provide a lump sum of cash to cover immediate expenses or bridge cash flow gaps.

c) Invoice Financing: Utilize invoice financing services where you can sell your outstanding invoices to a financing company at a discounted rate. This allows you to receive cash upfront rather than waiting for customers to pay.

Example: Let’s say your business experiences a temporary cash flow shortage due to a large upcoming expense. Instead of depleting your cash reserves, you decide to secure a line of credit with a bank to cover the expense and maintain sufficient working capital.

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9. Plan for Seasonal Fluctuations:

If your business experiences seasonal fluctuations, anticipate and plan for periods of increased or decreased cash flow. Adjust your operations, marketing strategies, and staffing levels accordingly to mitigate the impact on your cash flow.

Example: If you own a retail business that experiences higher sales during the holiday season, plan in advance by allocating additional cash reserves to cover increased inventory costs and potential cash flow gaps during slower months. By forecasting and budgeting for these fluctuations, you can ensure your business remains financially stable throughout the year.

10. Seek Professional Advice:

If you’re unsure about managing your business cash flow effectively, consider consulting with a financial advisor or accountant who specializes in cash flow management. They can provide guidance tailored to your specific business needs and help you implement best practices.

Cash flow analysis is important for businesses as it helps them to identify potential cash flow problems, manage their cash resources effectively, and make informed financial decisions. By analyzing their cash flows, companies can gain insight into their financial position and take appropriate measures to improve their cash position.

Example Table:

Month	Cash Inflows	Cash Outflows	Net Cash Flow
January	$50,000	$40,000	$10,000
February	$60,000	$50,000	$10,000
March	$70,000	$60,000	$10,000
April	$80,000	$70,000	$10,000
May	$90,000	$80,000	$10,000

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Cash Flow Formulas:

Cash Flow = Cash Inflows – Cash Outflows

Where:

• Cash Inflows refer to the money coming into the business, such as sales revenue, loans, or investments.
• Cash Outflows refer to the money going out of the business, such as expenses, salaries, or loan repayments.

By subtracting the total cash outflows from the total cash inflows, you can determine the net cash flow for a specific period. A positive cash flow indicates that more money is coming into the business than going out, while a negative cash flow suggests that more money is being spent than received.

The cash flow analysis is essential for evaluating the financial health and liquidity of a business, helping in decision-making, budgeting, and planning for future cash needs.

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Here are some common cash flow formulas along with explanations:

Operating Cash Flow (OCF): OCF = Net Income + Non-Cash Expenses + Changes in Working Capital

The operating cash flow formula calculates the cash generated or consumed by a company’s core operations. It includes:

• Net Income The company’s total revenue minus all expenses, including taxes and interest.
• Depreciation/Amortization: Non-cash expenses that represent the gradual reduction in value of assets over time.
• Changes in Working Capital: The difference in the company’s current assets and liabilities from one period to another, which reflects changes in cash flow from day-to-day operations.

Example:
Net Income = $100,000
Depreciation = $20,000
Changes in Working Capital = $10,000
OCF = $100,000 + $20,000 + $10,000 = $130,000

Cash Flow from Investing Activities (CFIA): CFIA = Cash Inflows – Cash Outflows

The cash flow from investing activities formula calculates the cash flow related to investment activities. It includes:

• Cash Inflows: Cash received from activities like selling long-term assets or receiving returns on investments.
• Cash Outflows: Cash spent on activities such as purchasing long-term assets or making investments.

Example:
Cash Inflows = $50,000
Cash Outflows = $30,000
CFIA = $50,000 – $30,000 = $20,000

Cash Flow from Financing Activities (CFFA): CFFA = Cash Inflows – Cash Outflows

The cash flow from financing activities formula calculates the cash flow related to financing the business. It includes:

• Cash Inflows: Cash received from activities like issuing shares or borrowing funds.
• Cash Outflows: Cash spent on activities such as repurchasing shares or repaying loans.

Example:
Cash Inflows = $80,000
Cash Outflows = $60,000
CFFA = $80,000 – $60,000 = $20,000

Net Cash Flow: Net Cash Flow = OCF + CFIA + CFFA

The net cash flow formula provides the overall change in cash during a specific period. It combines the cash flow from operating activities, investing activities, and financing activities.

Example:
OCF = $130,000
CFIA = $20,000
CFFA = $20,000

Net Cash Flow = $130,000 + $20,000 + $20,000 = $170,000

These formulas and examples demonstrate how cash flows are calculated and provide insights into a company’s financial performance. They help evaluate cash generation, investment activities, and financing decisions, enabling businesses to make informed financial decisions and monitor their cash flow position effectively.

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Direct vs. Indirect Cash Flow Analysis: Which Method is Right for Your Business?

There are two methods of cash flow analysis: direct and indirect. The direct method involves analyzing cash inflows and outflows by directly tracking the company’s cash receipts and payments. The indirect method, on the other hand, starts with net income and makes adjustments to determine the company’s net cash flow.

Cash flow analysis is a critical tool for businesses to manage their financial health. There are two methods of cash flow analysis: direct and indirect. Both methods provide valuable insights into a business’s cash inflows and outflows, but they differ in their approach. In this article, we will explore the differences between the two methods and provide examples of Excel tables for each.

1. Direct Cash Flow Analysis:

The direct method of cash flow analysis involves recording all the cash inflows and outflows of a business in detail. This method provides a more granular view of a business’s cash flows and is preferred by some businesses because it provides more specific information.

Example Table:

Cash Inflows	Amount
Cash Sales	$5,000
Customer Payments	$10,000
Interest Income	$500
Total Cash Inflows	$15,500

Cash Outflows	Amount
Purchases	$6,000
Salaries and Wages	$3,500
Rent	$2,000
Interest Expenses	$250
Total Cash Outflows	$11,750

| Net Cash Flow | $3,750 |

Formulas Direct Method:

1. Cash inflows: Add up all the cash received during a particular period, including cash sales, customer payments, interest income, and other cash inflows.
2. Cash outflows: Add up all the cash paid during a particular period, including purchases, salaries, rent, interest expenses, and other cash outflows.
3. Net cash flow: Subtract cash outflows from cash inflows to determine the net cash flow for a particular period.

2. Indirect Cash Flow Analysis:

The indirect method of cash flow analysis starts with the net income of a business and adjusts for non-cash transactions such as depreciation, amortization, and deferred taxes. This method provides a more simplified view of a business’s cash flows.

Example Table:

Net Income	$10,000
Adjustments for Non-Cash Transactions
Depreciation	$2,000
Amortization	$1,000
Deferred Taxes	$500
Changes in Working Capital
Accounts Receivable	($500)
Inventory	($1,000)
Accounts Payable	$750
Net Cash Flow	$12,750

Formulas Indirect Method:

1. Net income: Start with the net income of the business for a particular period.
2. Adjustments for non-cash transactions: Add back non-cash transactions such as depreciation, amortization, and deferred taxes.
3. Changes in working capital: Adjust for changes in working capital such as accounts receivable, inventory, and accounts payable.
4. Net cash flow: Add up the adjustments for non-cash transactions and changes in working capital to determine the net cash flow for a particular period.

In conclusion, both direct and indirect methods of cash flow analysis have their benefits and limitations. The direct method provides a more detailed view of a business’s cash flows, while the indirect method provides a more simplified view. Choosing the right method for your business depends on your specific needs and preferences. By using Excel tables and the appropriate formulas, businesses can effectively analyze their cash flows and make informed financial decisions.

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Steps to analyze cash flow using an example and Excel

Here are the steps to analyze cash flow using an example and Excel:

1. Create a cash flow statement: Start by preparing a cash flow statement for the period you want to analyze. This statement should list all the cash inflows and outflows during that period, organized into three categories: operating activities, investing activities, and financing activities.
2. Calculate net cash flow: The next step is to calculate the net cash flow for the period. This is simply the total cash inflows minus the total cash outflows. You can do this by subtracting the sum of the cash outflows from the sum of the cash inflows.
3. Review trends: Look at the net cash flow for each month or quarter and compare it to previous periods. Identify any trends, such as increasing or decreasing cash flow, and investigate the reasons behind them.
4. Analyze the sources and uses of cash: Review the cash flow statement to identify the sources and uses of cash. Are most of the cash inflows coming from operating activities or investing activities? Are the cash outflows mainly for expenses or investments? This analysis can help you identify any areas where cash is being used inefficiently.
5. Assess liquidity: Another important aspect of cash flow analysis is assessing the company’s liquidity. This involves calculating the current ratio and the quick ratio, which measure the company’s ability to pay its short-term debts using its current assets. You can use Excel formulas to calculate these ratios.
6. Make projections: Finally, use the information you have gathered to make projections about future cash flow. This can help you identify potential issues and make adjustments to improve cash flow.

Here is an example Excel sheet for cash flow analysis:

	A	B	C	D
1	Cash Inflows		Cash Outflows
2	Sales Revenue	$10,000	Rent	$2,500
3	Investments	$5,000	Salaries	$3,000
4	Loan	$2,000	Supplies	$1,500
5	Total	$17,000	Total	$7,000
6
7	Net Cash Flow	$10,000
8
9
10	Current Ratio	2.3	Quick Ratio	1.5

In this example, we have listed the cash inflows and outflows for a period, and calculated the net cash flow. We have also calculated the current and quick ratios using Excel formulas. This information can be used to analyze cash flow, identify trends, and make projections.

Another sample

Here’s an example Excel table for analyzing cash flow:

Category	Cash Inflows	Cash Outflows	Net Cash Flow
Operating Activities	$100,000	$75,000	$25,000
Investing Activities	$20,000	$30,000	-$10,000
Financing Activities	$50,000	$40,000	$10,000
Total	$170,000	$145,000	$25,000

Beginning cash balance: $50,000 Ending cash balance: $75,000

Cash flow coverage ratio: $25,000 / $40,000 = 0.625

In this example, the business had a net cash inflow of $25,000 for the period, which is a positive sign for its liquidity. The negative net cash flow in the investing activities category suggests that the business may be spending more on investments than it is receiving in returns. The cash flow coverage ratio of 0.625 suggests that the business may struggle to make its debt payments with its current level of cash flow, indicating a potential area for improvement.

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Incorporating risk management into cash flow analysis

Here’s an example Excel table for cash flow analysis:

Category	Amount
Cash inflows	$50,000
Sales revenue	$40,000
Investment income	$5,000
Loan proceeds	$5,000
Cash outflows	$45,000
Operating expenses	$35,000
Loan payments	$5,000
Investment purchases	$5,000
Net cash flow	$5,000

To incorporate risk management into cash flow analysis, you can identify potential risks that could impact your cash inflows and outflows. These risks can include changes in market conditions, supplier or customer defaults, or unexpected expenses. Once you’ve identified these risks, you can create contingency plans and allocate funds accordingly to mitigate their impact on your cash flow.

For example, if you’re a manufacturing company and your main supplier experiences a disruption in their operations, this could lead to delayed deliveries and a decrease in cash inflows. To mitigate this risk, you could identify alternative suppliers and allocate additional funds to cover any potential price increases or transportation costs.

Incorporating risk management into cash flow analysis can help you better understand the potential impact of risks on your company’s financial health and ensure that you have the necessary resources to overcome any challenges that may arise.

Example 1

Assume we have a company that operates in the retail industry. The following table shows the cash flow statement for the company for the year 2022:

	January	February	March	April	May	June	July	August	September	October	November	December	Total
Cash inflows	100,000	150,000	200,000	300,000	250,000	200,000	180,000	220,000	300,000	250,000	200,000	150,000	2,400,000
Cash outflows	80,000	90,000	120,000	150,000	160,000	180,000	200,000	220,000	230,000	250,000	270,000	300,000	2,300,000
Net cash flow	20,000	60,000	80,000	150,000	90,000	20,000	(20,000)	0	70,000	0	(70,000)	(150,000)	150,000

Now, let’s analyze the cash flow statement with a focus on risk management. We can use the following steps:

1. Calculate the total net cash flow for the year: In this case, the total net cash flow for the year is $150,000.
2. Analyze the cash inflows: We can see that the cash inflows are highest in September and October. However, there is a significant drop in November and December, which could be a cause for concern. To manage this risk, the company could consider implementing strategies to boost sales during the holiday season or diversifying their revenue streams to reduce reliance on seasonal fluctuations.
3. Analyze the cash outflows: We can see that the cash outflows are highest in October and November. To manage this risk, the company could consider negotiating better payment terms with suppliers or implementing cost-cutting measures to reduce expenses during this period.
4. Calculate the cash burn rate: The cash burn rate is the rate at which the company is spending its cash reserves. To calculate the cash burn rate, we can divide the total net cash flow by the total cash outflows. In this case, the cash burn rate is 6.52 months, which means the company has enough cash reserves to cover its expenses for just over six months.
5. Analyze the changes in cash balance: We can see that there are significant changes in the cash balance from month to month. To manage this risk, the company could consider implementing cash flow forecasting and monitoring tools to better predict and manage cash flow fluctuations.
6. Develop risk management strategies: Based on the analysis, the company could develop risk management strategies to mitigate potential cash flow risks, such as diversifying revenue streams, negotiating better payment terms with suppliers, implementing cost-cutting measures, and using cash flow forecasting and monitoring tools.

Another example

Here is another the Excel table example of a cash flow analysis incorporating management risk for the investment in the software company, along with an analysis of the results:

Year	Revenue	Variable Costs	Fixed Costs	EBITDA	Taxes	Net Income	Cumulative Cash Flow
1	$700,000	$280,000	$300,000	$120,000	$36,000	$84,000	$84,000
2	$840,000	$336,000	$300,000	$204,000	$61,200	$142,800	$226,800
3	$1,008,000	$403,200	$300,000	$304,800	$91,440	$213,360	$440,160
4	$1,209,600	$483,840	$300,000	$425,760	$127,728	$298,032	$738,192
5	$1,451,520	$580,608	$300,000	$570,912	$171,274	$399,638	$1,137,830

Analysis:

The cash flow analysis shows that the investment in the software company is expected to generate positive cash flow in each of the five years. The cumulative cash flow for the five-year period is expected to be $1,137,830.

However, the analysis also takes into account the management risk associated with the investment. The probability of the company achieving its revenue growth projections is estimated at 70%. This means that the expected revenue for year 1 is $700,000 (70% of $1 million), which is lower than the revenue projection of $1 million. This lower revenue projection has a ripple effect on the other financial metrics, such as net income and cumulative cash flow.

It is important to note that the management risk could be further quantified and incorporated into the analysis by adjusting the probability estimate, or by considering other risk factors that may affect the investment.

Overall, the cash flow analysis incorporating management risk provides a more realistic and nuanced picture of the investment’s financial performance, and can help investors make more informed decisions.

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Example 3

Sure, here is another Excel table example of a cash flow analysis incorporating management risk for a hypothetical investment in a retail business, along with an analysis of the results:

Year	Revenue	Variable Costs	Fixed Costs	EBITDA	Taxes	Net Income	Cumulative Cash Flow
1	$500,000	$250,000	$200,000	$50,000	$15,000	$35,000	$35,000
2	$600,000	$300,000	$200,000	$100,000	$30,000	$70,000	$105,000
3	$720,000	$360,000	$200,000	$160,000	$48,000	$112,000	$217,000
4	$864,000	$432,000	$200,000	$232,000	$69,600	$162,400	$379,400
5	$1,036,800	$518,400	$200,000	$318,400	$95,520	$222,880	$602,280

Analysis:

The cash flow analysis shows that the investment in the retail business is expected to generate positive cash flow in each of the five years. The cumulative cash flow for the five-year period is expected to be $602,280.

However, the analysis also takes into account the management risk associated with the investment. The probability of the company achieving its revenue growth projections is estimated at 80%. This means that the expected revenue for year 1 is $500,000 (80% of $625,000), which is lower than the revenue projection of $625,000. This lower revenue projection has a ripple effect on the other financial metrics, such as net income and cumulative cash flow.

It is important to note that the management risk could be further quantified and incorporated into the analysis by adjusting the probability estimate, or by considering other risk factors that may affect the investment.

Overall, the cash flow analysis incorporating management risk provides a more realistic and nuanced picture of the investment’s financial performance, and can help investors make more informed decisions.

Sources: Investopedia, Tipalti,

Photo credit: almariel1 via Pixabay

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