How to Create a Cash Flow Analysis That Unveils Opportunities

The way you manage your business’s finances has the power to make or break your venture. Cash flow analysis is the best way to gauge its health and decide whether it’s time to tighten your belt or plan for growth.

The importance of cash flow

Poor cash flow accounts for the failure of over two thirds of UK businesses. Without assessing cash flow, it’s difficult to predict how much money you have for payroll, inventory, customer retention strategies and, ultimately, long-term growth. But identifying the source and financial significance of your cash flow problems isn’t as simple as checking through your sales records.

A cash flow analysis is a recognised method to secure this control, providing an holistic view of your business’s financial wellbeing. If you’ve recently started a business, adopting cash flow analysis into your routine will help you get off on the right foot, acting as a preemptive safeguard for years to come.

What is a cash flow statement?

A cash flow statement is a financial statement that summarises the cash entering and leaving your company. It divides the concept of cash flow into three sections:

  • Cash flow from operating activities (CFO).
    This section explores the revenue-generating activities of a business, i.e. how much yours has generated from core business operations like sales. Normally, it takes the form of quarterly and annual reports. The ideal “cash flow from operating activities” would be at least enough income to cover all of your outgoings. This takes the form of at least a 1:1 ratio — operational incomings matching (or, even better, exceeding) outgoings.

  • Cash flow from investing activities (CFI).
    This section within your cash flow statement reports on the influence of investment gains or losses. These investments are known as “fixed” or “capital” assets, which are not expected to be consumed or converted into cash within the financial year. Examples of assets include new premises, company car or laptop. These assets are owned, not hired.

  • Cash flow from financing activities (CFF).
    This section within your cash flow statement looks at external capital-raising activities, including issuing stock to shareholders, buying stock back, making payments on a business loan or distributing dividends.

There are a number of ways to create a cash flow statement, including building your own templates, downloading one or using accounting software like Xero and Zoho Books.

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Calculating cash flow

A cash flow analysis begins with an examination of all the parts of your business that affect cash flow, such as:

  • Accounts receivable (money owed to you)
  • Accounts payable (money you owe)
  • Inventory
  • Credit terms (the set time window for customers to pay for purchases and the interest charged to them)
  • Cash acquired through the sale of assets
  • Payments for the purchase of assets
  • Business loans
  • Finance from outside investment

The basic means of calculating your cash flow is to compare your total unpaid outgoings to your total receivable income at the end of the month. When the former exceeds the latter, you spend more than you own. And whilst making a loss is part and parcel of running a small business, long-term this pattern will lead to cash flow problems.

To calculate your cash flow with a cash flow template, follow these steps:

  1. Enter your company’s total cash balance at the beginning of a full or half year, a year quarter or a single month.
  2. Enter your cash incomings and outgoings for the cash flow statement sections:
    1. Operating activities
    2. Investing activities
    3. Financing activities
  3. Add or subtract these incomings and outgoings from the original total cash balance.
  4. The final total — the increase or decrease left from the total cash balance — represents your net cash flow, i.e. your “bottom line”.

Analysing your cash flow statement

The more you run cash flow analyses, the more data you uncover and the deeper the understanding of your cash flow health gets. The basic calculation above is just one way of understanding your cash flow. Other calculations include:

  • Free cash flow.
    Free cash flow refers to the funds you have available after paying capital and operational expenses. To calculate free cash flow, use one of these three formulas:
    • Sales revenues – operating costs and taxes – required investments in operating capital
    • Net operating profit after taxes (NOPAT) – net investment in operating capital
    • Net cash flow from operations – capital expenditures
  • Operating cash flow to liabilities ratio.
    This ratio shows whether your current liabilities are covered by your cash flow, helping you gauge your company’s liquidity.

    The formula to use is: cash flow from operations ÷ current liabilities

  • Operating cash flow to sales ratio.
    This ratio is expressed as a percentage. It compares your operating cash flow with net sales to get an idea of your company’s ability to turn sales into cash. If your business is healthy, you should see your company’s sales grow in parallel to your operating cash flow.

    The formula to use is: operating cash flow  ÷ net sales (revenue)

  • Cash flow trends.
    The ratios above help you track your business’s health and measure your cash flow management. Once you have 12 months’ worth of financial data, you can analyse your month-over-month cash flow more accurately and design changes that help your business succeed.

The frequency with which you need to carry out a cash flow analysis depends on your industry and the size and condition of your business. If you started up recently, regular checkups will pave the way for good health down the line. Whereas if you’ve been established for a number of years, the added complexities of your size may warrant spreading out your analyses. The main thing is that you always have a practical and in-depth understanding of your business’s financial status.

This article is intended to offer helpful guidance and does not constitute qualified financial advice. Please consult an accountant or financial advisor if you have any questions.

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