fbpx

Why Cash Flow Analysis is Important for Your Small Business

Cash flow, put simply, is the migration of capital in and out of a business. However, many small business owners struggle with managing and sustaining their cash reserves.


There’s nothing quite like cash. It is necessary to start, maintain and grow business operations. However, many small business owners struggle with managing and sustaining their cash reserves. Flawed cash flow analysis or insufficient capital can drastically, and negatively, affect daily business operations, as well as business loan eligibility.

Cash flow, put simply, is the migration of capital in and out of a business. It is comprised of two variables: inflow and outflow. Inflow is capital that is received as a result of normal business transactions. This can include sales of goods and services, loans, lines of credit and asset sales. Outflow is capital leaving the business, and can result from business expenditures, loan payments and business purchases.

The ability to maintain these two variables so sufficient cash reserves are held at all times is critical for every small business. Developing a reliable cash flow system will help to manage these variables so there are no unexpected surprises that can result in a cash deficit. As Investopedia explains, “Savvy investors are attracted to companies that produce plenty of free cash flow (FCF). Free cash flow signals a company’s ability to pay debt, pay dividends, buy back stock and facilitate the growth of business. Free cash flow, which is essentially the excess cash produced by the company, can be returned to shareholders or invested in new growth opportunities without hurting the existing operations.”

 

The Cash Flow Analysis Blueprint

Income statements and profit and loss (P&L) records can be used to make approximations for future cash flow orientation. However, a cash flow statement can serve another, independent purpose. It can incorporate into its calculations, non-cash items and expenses to adjust profit figures. Not only do cash flow statements display changes over time, they also document total cash reserves.

For the most part, cash flow analysis is comprised of three components:

 

  • Financing Activities

    Financing activities are cash flow trends related to funding the business. Taking out a loan or a line of credit, for example, would be considered business inflow. The payment on the loan would be considered outflow, and both would be documented in the financing activities portion of the cash flow statement.

  • Investment Activities

    The investment activities portion of the cash flow analysis statement documents all incomes and expenditures resulting from long term investment purchases and sales. This includes property, assets, equipment and securities. For example, if a construction company purchases a new bulldozer this would be considered an investment activity and would be recorded as a cash outflow. If, after several years, the company decides to sell the bulldozer, it would be considered a cash inflow.

  • Operating Activities

    Operating activities considers net income and losses. By analyzing sales and business expenditures, non-cash items are adjusted to incorporate inflows and outflows of cash transactions.

Calculating cash flow statements and analysis can be a difficult task, particularly for a new small business. Seek out the advice of an accounting professional or trusted business advisor, or consider 3rd party software that can help make these calculations easier.

For more information on why cash flow forecasts are important, including recommendations for more accurate projections, download the whitepaper: Avoid Cash Flow Catastrophes.

 

© YFS Magazine. All Rights Reserved. Copying prohibited. All material is protected by U.S. and international copyright laws. Unauthorized reproduction or distribution of this material is prohibited. Sharing of this material under Attribution-NonCommercial-NoDerivatives 4.0 International terms, listed here, is permitted.

   

In this article