Cash flow analysis reviews a company's inflow and outflow of cash, assessing its ability to maintain adequate cash for operations and growth.
In an analysis, the team reviews all cash transactions over a specific period, including everything from operational activities to investing and financing decisions.
A well-executed cash flow analysis reveals valuable insights housed within the company’s raw finance data, such as liquidity, solvency, and future cash flow generation. Cash flow analysis lets businesses understand where money is going, get ahead of potential shortfalls, make the most of budget surplus, and more.
The two primary cash flow methods used in cash flow analysis are:
The direct method: This involves a detailed examination of each instance of cash inflow and outflow within an organization. It scrutinizes every transaction, from customer receipts to supplier payments, providing a comprehensive view of all cash-based activities. This method offers high accuracy but can be time-consuming due to its meticulous nature.
The indirect method: This starts with net income and adds or subtracts changes in balance sheet accounts to arrive at operational cash flow. It's based on accrual accounting rather than actual cash transactions. While this approach may not offer insights as granular as the direct method, it is simpler and less labor-intensive, making it more commonly used (especially when quick overviews are needed).
Both methods provide valuable insights into a company's financial health but serve different purposes. The choice between using one over the other often depends on the business's specific needs, such as the level of detail required or resources available for conducting the analysis.
When it comes to analyzing cash flow, there are three main categories to keep in mind: operational, investing, and financing. Let's take a closer look at each one.
Operational cash flow refers to cash from a company's regular business operations, such as sales revenue, payments for supplies and salaries, and other day-to-day transactional activities.
To calculate operational cash flow, you need to take net income and adjust it for non-cash expenses like depreciation, changes in working capital, and changes in deferred tax. If operational cash flow is positive, the company can generate more cash than it needs for everyday operations.
Investing cash flow refers to the cash involved in buying or selling long-term assets, such as property, plant, equipment, or investments in other businesses. When a company purchases an asset, it will result in negative investing cash flow. When an asset is sold, or any gains from investments are realized, there would be a positive investing cash flow.
Financing cash flow refers to cash flow involving owners or creditors of the company in the form of equity, loans, leases, or stock activities (issuing new stock, repurchasing existing stock, paying dividends to shareholders, repayment of debt principal, etc.).
Positive financing cash flow indicates more money was raised than paid out. If cash flow is negative, the company has distributed more funding.
Monitoring all cash flow sources closely on their statement of cash flows helps finance maintain financial health and make strategic decisions about the company’s future action and direction.
Accurate cash forecasting is vital for effective financial planning. It enables companies to anticipate potential shortfalls or surpluses, allowing time to strategize optimal allocation of resources. This foresight can prevent financial strain and facilitate uninterrupted operations.
Here are five of the best ways to increase the accuracy of forecasting and more accurately track a cash budget in your FP&A practice:
Budgeting is also pivotal to successfully managing and predicting cash flows. It acts as a financial blueprint, outlining projected income and expenses. By detailing anticipated revenues and costs—both fixed and variable—budgeting offers an overall view of potential cash inflows and outflows.
Budgeting is the cornerstone of efficient resource allocation. It also plays a role in spotting shortfalls or surpluses, making it integral to cash flow statement analysis and financial planning.
Optimizing the accounts receivable process significantly enhances cash management. Even the best customers can’t issue prompt payment if the process is difficult or unclear, so be sure to incorporate technology and tracking into the process for minimal friction.
Technology is the most effective way to ease AR management struggles. It creates a centralized source of truth about receivables, makes it easier for buyers to meet obligations, and reduces the manual labor and errors that bog down even high-performing accounting teams.
On the other side of the coin, managing your obligations to vendors optimizes cash utilization and preserves revenue for a stronger overall cash position. There are many ways to improve the AP process for better cash flow, such as:
Inventory optimization is one of the best ways to preserve cash position, as it prevents overruns that tie up cash and understock that may disrupt sales.
Maintaining sufficient stock to meet demand without tying up working capital in idle assets is a delicate balance. This practice prevents cash crunches, minimizes storage costs, and avoids disruption in product availability, thus driving business sustainability.
Here are five popular methods for managing inventory that also preserve cash flow optimization:
Strategic capital expenditures planning involves identifying, evaluating, and prioritizing large-scale purchases or investments contributing to a business's long-term success. It considers costs, benefits, risks, returns, business goals, timing, and financial capabilities to ensure alignment and fiscal discipline for growth and innovation.
While vital for business growth and innovation, capital investments significantly influence cash flow. The immediate outflow of funds for such purchases may decrease available cash reserves. However, these expenditures often lead to increased operational efficiency or revenue streams over time, boosting the company's overall cash flow.
Be sure to:
Continuous monitoring and cash flow statement analysis is crucial for financial stability and optimizing working capital. It helps identify trends, predict future needs, and make informed decisions.
Use these metrics as part of your cash flow analysis to keep a comprehensive view of cash position:
These metrics together present a comprehensive view of a company’s cash flow situation and help in making informed financial decisions. Using them as part of a continuous monitoring program provides the maximum insight into cash position and financial health.
The right technology makes cash flow analysis and management easier and more insightful. Advanced software tools like Cube offer real-time tracking, predictive analytics, and automated workflows to streamline processes and enable proactive measures in maintaining cash position.
Software also improves forecasting, metrics tracking, budget performance, and reporting capabilities. With advanced algorithms for predictive analysis, businesses can anticipate future cash positions accurately.
Integrating technology into financial processes also offers operational benefits like more cost efficiency in administering finance activities, scalability for continued control and visibility as the company grows, and better security for maintaining control over data and processes.
Integrating advanced software tools into the FP&A process streamlines cash flow analysis and every other planning activity. A system like Cube can boost decision-making, improve forecasting, streamline metrics tracking, and fine-tune budget processes—all leading to more accurate reporting and cash flow statement analysis.
Ready to join FP&A leaders in adopting these better strategies using the best software tools? Request a free demo of Cube today.