Cash Flow Analysis FAQs

What is cash flow analysis and why is it important for business?

Cash flow analysis involves examining the movement of money in and out of a company over a defined timeframe. Where it originates from, where it goes and the corresponding amounts. The net cash flow for a period is calculated by subtracting current liabilities from current assets.

Incomings will typically consist of sales revenue, loan proceeds and investment returns, with outgoings encompassing various expenses like salaries or rent payments, as well as utility bills and loan repayments. For SMEs, having a decent understanding of their cash flow is important because it means the valuable insights you gain from the reports can be made actionable, driving business operational efficiency and ensuring your finances are managed properly.

There are three crucial metrics that need to be understood to perform a complete cash flow analysis, and are important as they differentiate each category of cash movement:

• Operating Activities — Including cash transactions related to any core operations occurring within your business. Revenue from sales and expenses for things like salaries or rent will appear here, with a positive cash flow suggesting good business health.
• Investing Activities — Covering any transactions for purchases or sales of your business’s long-term assets. Investments in anything from equipment to property will appear, as well as any other unique investments to your sector. This cash flow highlights how much a business is buying into its own future, which means cash flow may be negative if investments are high.
• Financing Activities — Including business transactions related to debt, equity or dividends. Debts and Loan numbers will appear here, including things like stock or dividend payments, helping to establish the data that potential shareholders will be interested in.

It should be noted that analysing your cash flow goes beyond just keeping a track of your cash, although this is of course a key component, a thorough analysis is about predicting your future inflows and outflows as well. Through forecasting cash flow, an SME can prepare themselves for the future by ensuring they have the necessary funds to meet their commitments or take advantage of new opportunities.

Importance of Regular Cash Flow Analysis

Regular cash flow analysis is also important for SMEs to keep a continued view of their financial trends, as it helps to identify potential challenges before they can escalate, and also means any contingency plans remain accurate and effective should an emergency occur. Below we’ll go through the main benefits that SMEs we work with speak about:

• Improved Financial Planning: Businesses are advised to follow regular cash flow analysis because it helps so much with their budgeting and financial planning, and of course means greater chances of remaining afloat in their industry. With that scrutiny SMEs can make better choices about their expenditures and investments, as well as figure out where to allocate their resources going forward.
• Enhanced Liquidity Management: Once a business begins to understand its cash position from detailed analyses, they should gain a much better vision of how to manage their liquidity, and over time it will keep them on track towards maintaining the right amount of cash to deal with ongoing short-term liabilities.
• Increased Investor Confidence: For investors and lenders interested in conducting cash flow analysis, it can provide a clearer picture into the overall financial well being of a business, and helps them to gauge whether that business could generate the necessary cash to sustain operations and repay loans on time.
• Operational Efficiency: An SMEs capacity to understand cash flow and how best to utilise their own is often reflected in how its operations function, and a concise cash flow analysis can expose problems within an operation, and also suggest ways in which to improve them.

Getting Started with Cash Flow Analysis

Let’s start going through some of the key steps that SMEs are advised to follow if they want to ensure their own cash flow analysis is being performed correctly:

1. Get your financial statements in order: Having your income and cash flow statement, as well as your balance sheet for the specific time frame you are intending to review will be necessary to begin within.
2. Keep track of Cash inflows and outflows: It will be necessary to keep structured and thorough records of any and all cash inflows from things like sales and investments, and the same for cash outflows that involve expenses or loan repayments.
3. Use accounting software tools: In the current year businesses are only putting themselves at a disadvantage if they are not fully utilising the range of third party fintechs out there, from Pulse, to Quickbooks and Xero, as well as many the many open source bookkeeping tools that are available to simplify and automate cash flow analysis processes.
4. Regular reviews: This is most important for maintaining an understanding of the performances of your different cash flows, helping ensure that numbers do not become inaccurate, which can lead to numerous financial problems down the line because your strategies will be based on the incorrect projections.

Practical Tips for Effective Cash Flow Management

With those key steps in mind, let’s next have a look at some tips that we frequently hear being passed around amongst SMEs that helps them with their cash flow management:

• Monitor your receivables: Keeping an eye on your payments will help ensure a continued timely collection of any outstanding accounts receivables, this will play a big part in maintaining your business’s cash inflows.
• Controlling expenses: By watching out for excessive expenditures, SMEs should find it easier to stay on top of expenses, and they’ll find it easier to avoid draining important cash reserves in the long term.
• Prepare for the Future: Always plan ahead and use cash flow forecasts to prepare for any potential needs but also opportunities that can be capitalised on if they present themselves.
• Build up a Cash Reserve: Setting aside a cash buffer is highly advisable, regardless of the business’s industry or sector, as a reserve of cash will help to handle issues like unexpected costs or survive unfortunate turns of events like the recent Covid-19 pandemic.

We will always advise business owners and SMEs to familiarise themselves with the ins and outs of a cash flow analysis if they want to develop their small business financial intelligence. Once the correct metrics are analysed and insights are obtained and acted upon, the benefits of the processes quickly become clear, and those same businesses can start developing their financial strategies for achieving long term success.

How does cash flow analysis differ from profit and loss statements?

Profit and loss statements (P&L) compared to cash flow analysis differ because they are two separate metrics, covering two different areas of a business’s financial performance — P&L represents the money left after expenses while cash flow forecasts track the movement of cash either into or out of a business.

When you start exploring P&L, (otherwise known as an income statement), you will be able to zero in your business’s income and expenses during a specific timeframe, and completed correctly, should detail an enterprise’s ability to successfully generate profits. Your P&L statement will comprise of financial data on the following:

• Revenue: Any income a business earns by selling its goods or services to customers.
• Cost of Goods Sold (COGS): Any direct costs involved in the production of goods sold or delivery of services to customers.
• Gross Profit: To figure out gross profit you can minus your COGs from revenue.
• Operating Expenses: Unlike COGs, operating expenses include any costs that aren’t tied to the production of goods sold or delivery of services.
• Net Profit: This is your bottom line, to figure it out you can minus total expenses from total revenue.

With these metrics in mind we can see the P&L statement provides an accounting perspective on profitability but fails to provide a detailed picture of cash inflows and outflows. If we look at a cash flow statement, we’ll see that it gives details on how cash enters and leaves a business instead, through taking accurate financial data from operating, investing, and financing activities.

How their differences play out in practice:

• Timing Differences: Companies typically create profit and loss statements using accounting, which involves recognising revenues and expenses when they are earned or incurred regardless of when cash exchanges hands. This approach can sometimes result in situations where a company runs into cash flow problems, because it has been appearing profitable when on paper but suddenly faces challenges if the cash they need has not actually been received yet.
• Non-Cash Transactions: Numerous non-cash items will typically appear on a business’s P&L – things like depreciation and amortisation that affect enterprise profitability but not cash flow statements. For cash flow analysis however non-cash items are excluded and just cash transactions are important.
• Capital Expenditures and Loan Repayments: These cash outflows are significant expenses that are not included in the P&L statement but do play a crucial role in the cash flow statement. A case might involve a company buying equipment that results in a cash outflow then list it under investing activities. This will be noted in the cash flow statement without having any direct impact on the P&L.
• Understanding Liquidity: We can use a business’s cash flow statement to gain an understanding of the liquidity position of an enterprise (ability to meet short term financial obligations), and we’ll also learn that a business could well be profitable but still be struggling with liquidity if there is not enough cash to pay the bills.
• Financial Health and Sustainability: P&L might provide a business with a snapshot into its profitability, but it’s the cash flow statement that will give a solid idea of an enterprise’s overall financial health, as well its ability to sustain itself over the coming periods.

When you start breaking it down the different purposes that both P&L and a cash flow statement serve become clear, while both being important for assessing an enterprise’s performance. Their combined focus will help to provide a comprehensive picture of both your business’s financial health, and its operational efficiency.

What are the key components of cash flow analysis?

A business’s financial records will typically show cash flow on a statement as net cash flow, however there are three different types of cash flow that make up this number, and to be able to perform a succinct cash flow analysis, they each need to be understood, and data for each obtained. Let’s take a closer look at each of them:

Cash Flow from Operating Activities

To  get a solid grasp of the components of a cash flow analysis let’s look over some examples of the cash generated from core business activities, that way we can get an illustrated idea of exactly what is included in cash flow received from activities like sales and cash used for operating expenses:

• Cash receipts from sales: These numbers will be totalled from goods and services, and will include cash sales as well as collections from accounts receivable.
• Payments to suppliers: Any cash that went out to material suppliers, as well as inventory and any other goods required for production.
• Wages and salaries: Including payments made to your employees, it will also mark bonuses and benefits, along with labour.
• Utilities and rent: Anything your business pays out for essentials such as water and electricity, or rent for offices and production spaces as well as the internet supplying them will be listed.

Why it’s important: Maintaining the cash flow from a business’s operations is crucial for its short and long term health, and is of course necessary for maintaining operations and pushing growth. A healthy cash flow also demonstrates a company’s capacity to produce cash and fund its operational costs, which is important for potential investors, or financial lenders if there is ever a need for external funding.

Operating activity insights:

• Accountants receivable management: This requires an efficient method for promptly collecting receivables, and without being thorough it is very likely that your business will fall into a cycle of cash shortages, even if it appears profitable on paper.
• Inventory management: Once again, efficient and prompt planning for balance is necessary to ensure too much inventory isn’t tying up your cash, and it’s important to stay on top of to avoid stockouts and sales losses.
• Expense Control: Monitoring and managing your business’s expenses on a regular rota is also a positive must for maintaining a healthy cash flow, and by identifying then cutting unnecessary expenditures you will improve the overall wellbeing of your enterprise.

Cash Flow from Investing Activities

Moving onto investing, let’s take a look at some typical examples of cash that many of the business owners we work with discuss as being used for and generated from their investments in long term assets:

• Purchasing equipment and machinery: While investment purchases will be marked as outflows, they will be for the betterment of the company, so a net for production and efficiency.
• Selling property or equipment: These numbers will come from gaining cash inflows from selling off unused or old assets, which in most cases is beneficial, however may show signs that a company is struggling to keep up with its short term financial commitments.
• Investing in securities: Often seen in a positive light, purchasing stocks and bonds or other financial instruments is typically a sign that a business has a healthy cash flow.
• Any proceeds from selling investments: Money from reselling investments can and should be reinvested in the business, and used to acquire new investments that will support your long-term strategies.

Why it’s important: Investing activities effectively illustrate how a business and its leaders distribute their resources for expansion, and while a negative cash flow doesn’t necessarily spell bad, it could just mean that investments are being made now that will help that future expansion.

Investing Activity Insights:

• Capital Expenditures (CapEx): These funds are historically used by companies who want to acquire or improve their established assets and might involve buildings, machinery, or any relevant equipment. They essentially play the role of maintaining and expanding your business’s ability to produce the goods and services it offers.
• Return on Investments (ROI): Figuring out the return on investment you’ll make from products and services will be crucial for making the right decisions when it comes to allocating resources efficiently, as it’s important to evaluate them correctly based on their ability to generate positive cash flow.
• Depreciation Impacts: Even though depreciation is considered a cash expense it will also reflect on the gradual wear and tear of your business’s assets over time, so understanding exactly how it will affect your cash flow will remain important for planning future capital expenditures.

Cash Flow from Financing Activities

Lastly we come to cash flows from financing, the section of your cash flow statement that will include any cash transactions involved with financing your business. It could include borrowing money, repayments on any outlying facilities, or something like equity transactions, let’s take a look at some more detailed examples:

• Issuance of stocks or bonds: These numbers will be a record of any cash inflows made from your business raising capital through either equity or debt.
• Any loan repayments: This will always see cash going out to repay borrowed funds, and is not unusual for any healthy business that is using debt to achieve longer term success and growth.
• Dividend payments: Any cash being distributed to the shareholders of a business throughout any period are listed as dividends.
• Borrowing money from a lender: Banks or alternative lenders like Nucleus Commercial Finance will result in cash inflows to a business as funds are secured and payments received.

Why it’s important: The significance of financing activities has always lain in the fact that they reveal how well a company is supporting its own operations and expansion, as well as how it rewards its shareholders. On closer analysis, positive cash flows here should indicate that a business has acquired some funding, and negative might suggest repayments and dividends.

Financing Activity Insights:

• Managing debt: It has always been essential for business owners to fully grasp the terms and conditions of any debt they take on, and you should always speak to a financial advisor before going ahead with that choice. Debt management, done well, means your business can meet its obligations without compromising on operations.
• Equity financing: While selling shares might reduce a business’s ownership stakes, it can provide cash without any obligations of repayment, so the pros and cons need to be considered carefully before committing to any choices.
• Dividend policies: The dividend policy of a company will influence its cash flow in a way where paying high dividends will likely appeal to investors, but can strain its cash flow reserves at the same time, so again, should be considered carefully.

Additional Cash Flows to Consider

Net Cash Flow: A business’s net cash flow is the outcome of all money coming in and going out, showing the overall shift in its cash position over the designated period, and is ideal for understanding your business’s liquidity and general financial condition.

Cash Flow (FCF): cash flow is determined by subtracting Capital Expenditures from your Operating Cash Flow and is another measure that can be used to see how much money you’ll have left over after maintaining or expanding assets. Business owners can use this metric to evaluate their financial adaptability, with a positive FCF indicating that the your business will have enough funds to pursue growth opportunities.

Some Practical Cash Flow Analysis tips

• Regular Monitoring: By making cash flow analysis a regular part of your strategy schedule you will be more likely to keep your finances stable as you will always be aware of your financial status, and we suggest at least a monthly review to achieve this.
• Forecasting: By using your historical financial data, as well as the combination of market trends (which will require your own due diligence), your planning for upcoming expenses and investments will be much more thorough and forecasts more reliable.
• Scenario Analysis: Scenario analysis is a great way for business leaders to assess potential outcomes of different financial outcomes, and is typically split into three categories, those being best and worst case, and most likely. This kind of analysis is great for making strategic decisions because you can get a general idea of how the cases will affect your business before putting any into practice.

Fully comprehending the key components of a cash flow analysis will help businesses manage their liquidity and better plan for future growth, as well as make more informed financial decisions, which is why enterprise owners should get themselves familiar with the process so they can make it a regular part of their business strategy.

How often should cash flow analysis be conducted?

Whenever we speak to business owners about cash flow analysis, the status quo is to review cash flow every month, that way you can be certain of what is coming in and going out, but more importantly, when you can expect these cash inflows and outflows to occur. There are also quarterly and yearly, and in some cases much more frequent cash flow analysis that business owners are encouraged to perform, so let’s take a closer look at the options.

Benefits of monthly cash flow analysis:

To illustrate further why monthly cash flow analysis is the ideal option for maintaining a complete view over your business’s financial health, let’s break down some of the key reasons, and how they can bring you into better financial management.

• Timely Insights: With monthly reviews, the frequency means you can spot financial trends and react to address escalating issues more promptly, this also applies to any unexpected changes in your revenue or expenses.
• Budgeting and Planning: With a monthly cash flow analysis you can also maintain your budget much more accurately and efficiently, this is due to the fact that it allows you to compare your current cash flow with projections, then adjust your plans accordingly. By always being prepared for expenses, you can also allocate your resources more effectively.
• Seasonal Adjustments: While not relevant for most business models, companies with seasonal variations can still benefit from a monthly cash flow analysis due as you can grasp and pinpoint the points in the year when fluctuations in revenue occur, this also means you can plan better for those periods where sales fall off, then maximise during peak seasons.
• Improving Cash Management: One of the most important things for any business aiming to maintain a healthy cash flow, regular analysis will highlight areas where that cash flow can be improved, and areas like receivables or unnecessary expenses can be put under scrutiny to figure out any wasteful losses.
• Building Investor Confidence: This is particularly important for companies who are pushing for large scale expansion, due to the fact that lenders and investors have always looked favourably on a brand that can demonstrate that they regular monitor their cash flow, as it shows good cash management and a commitment to financial health.

Depending on the age, size, or sector of your business, where cash flow is volatile or you are in a growth phase, it is even advisable to monitor your cash flow as often as weekly, or in some extreme cases daily while that period lasts, as it will certainly help keep a grasp of your liquidity, and ensure an even more precise picture of any cash inflows and outflows, helping to meet obligations with further stresses or difficulties.

Quarterly and Annual Cash Flow Analysis

Although we suggest committing to monthly cash flow analysis, there are still broader reviews you should do alongside them to get a bigger picture of your inflows and outflows across the year of trading, so let’s look at their benefits:

• Quarterly Cash Flow Analysis: As mentioned, alongside monthly reviews, conducting a more thorough quarterly analysis means you can get a more holistic view of the business’s financial well being, as well as getting some insights on the effectiveness of your business strategies over those monthly period reviews. Broader adjustments can be made from the results of the cash flow analysis, and should ideally reflect the positives of the work you have done month over month.
• Annual Review: Longer term planning and strategy development can be applied through annual cash flow reviews, as you can get a complete view of your business’s overall performance, and these three separate cash flow analysis (Annual, quarterly, and monthly or shorter if necessary) should each be used in conjunction with each other to get the best handle on your cash flow as possible.

Using Technology for Cash Flow Analysis

There are a number of different technological methods that businesses have available for use in the current year, and although if you are a business owner you are likely already using some of them, let’s break down the options to demonstrate their uses:

• Accounting Software: By not making use of accounting software like our very own Pulse, businesses are putting themselves at a financial disadvantage, and there are now many trusted fintech brands on the market that can help. Pulse integrates with the majority of these brands, and names like Quickbooks and Xero, particularly when combined with Pulse, can help to automate and streamline your cash flow analysis.
• Forecasting Tools: By implementing forecasting fintech tools, business owners can get a prediction of their future cash flows based on historical financial data, and it helps a lot in preparation of avoiding potential cash shortages or any future financial requirements. Again, this is something that Pulse can help SMEs with.

Hopefully this makes things clear why monthly assessments are important for business strategy and growth, with more frequent reviews better illustrating how cash flow fluctuates and what business owners can expect of their cash flows. Quarterly and annual reviews are also important, and each compliments each other, combined with the use of fintechs to make your cash flow analysis smoother and more bearable, you can ensure you are a step ahead of any competitors who do not take their cash flow so seriously.

What Tools and Methods can I use for Effective Cash Flow Analysis?

The Fintech revolution has been a blessing for businesses across all industries and sectors, particularly the financial sector where fintech tools can be utilised by accountants and financial advisors to help SMEs get a better grasp of their financial wellbeing. Cash flow analysis is critical for this, and in helping business owners sustain the longevity of their brands.

Even prior to the fintech revolution there were many useful tools that SMEs and their advisors could use to perform a rigorous analysis, however technology is increasingly removing the need for human intervention, and with it, any risks of human error. From classical spreadsheets, to modern accounting software, to specialised cash flow management tools, the list of methods is growing, and are here to help you manage and analyse your cash flow effectively. Let’s take a look below:

Spreadsheets:

One of the most traditional, still useful and used methods for cash flow analysis has always been the spreadsheet. Modern versions like Google Sheets and Microsoft Excel are heavily used, and not just for financial reasons. They allow users to create detailed cash flow statements that can track both cash inflows and outflows and also help you forecast your business’s future cash positions. While spreadsheets offer flexibility and plenty of customisation that is useful for niche needs, they do require frequent manual data inputs that, as previously mentioned, are at risk of human error, where incorrect numbers will lead to false projections and potential problems for your business along the way.

Accounting Software:

There are many well established and trustworthy third party modern accounting softwares available on the market today, with brands like Quickbooks, Xero, and Sage, leading the way, particularly in the UK, helping businesses analyse their cash flow. Although they each offer unique perks and some are more suitable to businesses of different sizes, the majority of these tools will automate the facets of your cash flow management. Key metrics like transaction tracking and financial reporting or forecasting are performed by the software by integrating with your bank account, and with your permission, financial data is then pulled and aggregated to provide real-time data while greatly reducing the need of manual updates.

Financial Dashboards:

The intuitive financial dashboards offered by many modern fintech companies – our own Pulse being one of them – grant a more visual way for business owners and their financial advisors to grasp the data of their cash flow analysis. This is achieved by consolidating data from open accounting and open banking sources, then aggregating the numbers to generate a comprehensive overview of your financial status. Key metrics can then be displayed, in the case of Pulse, in easy to grasp infographics such as bar charts and line graphs, breaking down otherwise complex numbers into formats that can be understood by the layman.

Specialised Cash Flow Management Tools

Specialised cash flow tools like Float that have been designed specifically for financial management will integrate with other apps such as the priorly mentioned Xero, empowering business owners with advanced forecasting abilities and improved scenario planning through the detailed cash flow reports that are provided. When utilised effectively, cash flow management tools can assist businesses in predicting potential cash shortages, as well as allowing for proactive financial management. With the idea of specialised tools in mind now, let’s start exploring why our tool, Pulse, is quickly becoming one of the most talked about cash flow analysis tools on the market for SMEs.

Pulse: The Comprehensive Solution for SMEs

Our cutting edge fintech tool, Pulse, is capable of boosting the cash flow analysis of your SME by integrating with established Open Accounting and Open Banking brands, then, on your allowance, aggregating your financial data to produce useful actionable insights. With your real-time financial data and our AI driven dashboard, we generate easy to grasp infographics and breakdowns of your data, covering your most important metrics — Turnover trends, gross margin, debtor and creditor ratios, and income statements.

Our aim was to create a simple yet powerful tool that SMEs can use to help businesses anticipate their financial positioning while capitalising on the insights we generate. To ensure you miss nothing, monthly reports are sent to your inbox with all the key information highlighted that you need to effectively manage your finances. We want to empower SMEs with a comprehensive view of their cash flow so they can convert that data directly into financial intelligence, meaning you can make better decisions and improve your strategic planning. By helping SMEs in this way, we have been able to prove ourselves as an indispensable tool for business owners and cash flow analysis.