Cash flow is arguably the most important measurement of your company's financial performance. Perhaps even more so than profitability. After all, making a profit on paper is great, but without cash on hand you can't pay your staff, restock inventory or make future investments.
When it comes to measuring the health of your cash flow, it's not enough to just check your bank account balance. You'd gain much more insight by running even a basic cash-flow analysis. This cheat sheet of the key concepts will walk you through how to do just that.
Cash-Flow Statement Basics
Cash flow is one of the three main financial statements, along with your balance sheet and income statement. The balance sheet shows what your business owns and owes, the income statement shows whether you made a profit or a loss over the last period (month, quarter, year, whichever time period you pick) while the cash-flow statement measures whether your cash balance grew or shrank over the past period.
The way the cash-flow statement does this is by adding up all your inflows, when money comes in, and then subtracting all your cash outflows, when you spent money. If the total figure is positive, you should have more cash on hand than when the period started, while if it's negative, you will have less.
Key Concepts for Cash-Flow Analysis
Your statement should record all the cash inflows and outflows each month and divide them into three main categories:
- Operating activities. This will be the biggest section. It covers inflows like making sales and collecting payment on your accounts receivables/invoices and all the outflows from running your business (paying staff, rent, utilities, restocking inventory, etc.)
- Investment activities. This category covers the purchase and sale of business assets unrelated to your day-to-day operations. This could be an outflow because you bought a new building or a cash increase because you sold an unused piece of equipment.
- Financing activities. This covers money going in and out from business loans, investors and for paying a dividend to the business owners.
With this information, you can see why your cash position changed. Let's say your balance grew by $50,000. If you have more money because of strong sales, that's obviously a sign of a healthy business. On the other hand, if sales fell but you have more cash because you took out a loan, that's less encouraging. These are two very different situations, but if you only looked at your bank balance, you'd miss this information and risk having your cash flow go off-track.
You don't need to be an accountant to perform a decent cash-flow analysis.
Cash-Flow Analysis Template
Business tax software can create your cash-flow statement and update it every month with your business results. If you don't have tax software and need help building out your cash-flow statement, there are a few different free templates available online. These templates primarily focus on operating cash-flow activities, as these will be most of your inflows and outflows. They then have a separate section at the end where you add in the investing and financing cash-flow activities.
However, some of these templates don't include a box for unpaid customer invoices. This is technically the correct way to prepare financial statements, as that information should be on your balance sheet. But if you want one easy cheat sheet, that may be a good data point to add to your cash-flow analysis template.
When your unpaid accounts receivable balance starts to grow, that could be a sign of potential cash-flow trouble. Even though you're making sales, you don't have the money on hand because clients haven't paid their bills. Speeding up the collection of receivables is one way to help improve your cash flow, which is why you may want to track this balance on your template.
Cash-Flow Management and Forecasting
As you review changes in statement, you'll find ways to improve your cash-flow management. For example:
- You notice a spike in seasonal sales during the winter when your cash grows dramatically, but then falls in later months. This would keep you from overspending during good times.
- You notice that some cash outflows are creeping up. Perhaps inventory is suddenly costing more and squeezing your margins. In this case, you could try increasing your prices or cutting other expenses to offset the cash loss.
- If you notice that your accounts receivables are growing, you could adjust terms with your clients, so that they have fewer days to make payment or they could receive a discount for early payment.
Not only can cash-flow statement analysis help you understand past results, it can also prepare you for future cash-flow challenges with forecasting. Try to predict what your cash will look like by the next month or quarter based on your historical trends. This way, you're proactively planning your finances, rather than just reacting to business swings. If your prediction is off, consider what went wrong with your assumptions, so you can adjust your next forecast.
You don't need to be an accountant to perform a decent cash-flow analysis. By using this cheat sheet, you could help figure out what's going on with your money—and find ways to put yourself in an even stronger financial position.
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