Regular cash flow analysis is one of the most important things you can do for your business. These analyses provide a snapshot of financial health and help identify problems before they become serious. Think of it like a checkup with your doctor, but without the needles and waiting room magazines from 2009.
That being said, the quality of each analysis depends on the processes that underlie it – in other words, what’s under the tip of the iceberg.
Are you using traditional cash management strategies – scouring spreadsheets and struggling to generate position reports – or modern strategies like automated cash flow analysis that provide a real-time, granular view of cash, boost revenue, and save the treasury team tens of hours each month?
Below, we’ll look at each of these strategies in more detail, but let’s start at the beginning – what is cash flow analysis, and why is it so important?
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What Is Cash Flow Analysis?
Cash flow measures the money that comes into and goes out of your business over a specific period, say a year or a quarter. Cash flow analysis, on the other hand, asks whether that cash flow is sufficient to pay for day-to-day operating expenses and liabilities, or to finance investments.
But it’s more than that: analysis helps you track your cash, telling you where it’s coming from and where it’s going. What percentage of your liquidity is coming from sales? Are you relying too much on outside investors?
By helping answer these questions, cash flow analysis provides a roadmap for present and future decision-making.
It’s important to note cash flow is not the same as profit – where cash flow is specifically a measure of liquidity, profit (as measured in the profit and loss statement) can include non-cash transactions as well as orders that haven’t been paid for yet (accounts receivable).
A business’s current liquidity is known as its cash position.
Why is Cash Flow Analysis Important?
By guiding decision-making, a clear view of cash position helps a business thrive and grow sustainably.
For instance, cash flow analysis will tell you if you’re operating at a loss and headed towards a cash crunch. If so, you know you need to increase financing, scale back expenses, or boost sales (or a combination of these). In contrast, you may have extra cash you were unaware of – cash that could be reinvested in the company or put towards high-interest loans.
Cash flow isn’t always obvious. If your company’s profitable, for example, it’s easy to assume it’s healthy. However, it’s actually possible for it to experience negative cash flow while profitable. Cash flow analysis helps reconcile these differences.
Regular analysis of cash flow can also help bring on new investors. Since they can see where money’s coming from and where it’s going, they can evaluate how much the company is reinvesting in expansion through capital expenditure, for instance.
But how can they (and you) tell where money’s coming from and where it’s going? The answer is that the cash flow statement – one of the three financial statements along with the balance sheet and the income statement – divides cash flow into three types, helping you determine which area of your business is driving specific inflows and outflows.
What Are the Three Types of Cash Flow?
The three types of cash flow recorded in the cash flow statement are:
- Cash flow from operations
- Cash flow from financing
- Cash flow from investing
Cash flow from operations is just what it sounds like – the amount of money earned from making sales, minus the amount of money spent to keep the business functioning (rent, salaries, etc.) Note that cash flow from operations does not include capital expenditures, for example plant, property, and equipment (PP&E).
Cash flow from investing does include capital expenditures. You’d also evaluate stocks and securities here.
Finally, cash flow from financing measures income from investors and creditors against outflows like dividend payments.
These three types are added together to determine your net cash flow, located at the bottom of the cash flow statement. If cash flow is consistently negative, the business could be headed towards bankruptcy. But by allowing you to pinpoint why it’s negative, the cash flow statement helps you course correct.
For example, say you have negative operating cash flow. By looking at your cash flow statement, you realize this is because you have too much liquidity tied up in inventory – in response, you’d know to more closely manage your inventory levels going forward by scrutinizing sales data.
Cash flow from operations is the most important of the three types. Generally, you’ll want it to be positive because you want your operations to be self-sustaining – what if investors pull out, or you run out of investments to sell?
Sometimes, it’s ok to have a negative cash flow from investing or financing – dipping into the red a bit to grow is a proven strategy, especially for newer businesses. However, both ultimately depend on cash flow from operations – is this sustainable? Will you be able to pay what you owe?
Cash flow forecasting – a tool closely related to cash flow analysis – helps answer these questions.
Cash Flow Analysis vs. Cash Flow Forecasting
Cash flow forecasting is the other side of the coin of cash flow analysis. Where cash flow analysis evaluates historical information to determine the company’s current cash position, cash flow forecasting uses historical data to project what the company’s future cash position will be.
Doing this helps ensure you don’t run out of money – something that may seem obvious, but one of the most common reasons businesses fail.
It also helps line up outflows and inflows. For instance, by reducing customer payment times, you ensure the company has enough liquidity to pay back a loan that’ll come due in a few months. When paired with cash flow analysis, cash flow forecasting forms the foundation of a successful liquidity management strategy.
Challenges of Cash Flow Analysis/Forecasting
Up until recently, there was only one way to do cash flow analysis – with spreadsheets. Yes, with spreadsheets you’ll eventually get your current cash position, and a reasonable estimate of your future one, but not without plenty of hassle first.
The main problem with spreadsheets is that everything’s done manually. Thanks to human error, this can result in flawed data. In fact, according to IBM, 88% of spreadsheets contain at least one mistake.
Your cash flow analysis and cash flow forecasting are only as good as the data that’s fed into them.
Once someone notices the cash position calculated doesn’t line up with what’s in the bank, more time has to be spent on reconciliation – tracking down one or more errors and redoing the process.
Recording data across bank portals can also be a huge time sink. Treasurers must go from bank portal to bank portal and isolate data relevant to each of the three categories of cash flow.
Only then can they generate their cash flow statement.
Tracking down data, and then manually creating cash flow analyses and forecasts, can take tens of hours each month – time that could be spent analyzing the data and helping determine the direction of the company.
Finally, spreadsheets aren’t a cloud-based tool – they weren’t meant to be edited by people in various departments. This can lead to the problem of data silos, where it’s difficult to determine which version is the most current.
How Automation Modernizes Cash Flow Management
All these problems spring from manual processes, which is why the solution is automation! First, when transactions are recorded automatically, there’s no chance of transcription error.
APIs allow transactions to be recorded in real-time by linking with bank accounts. This provides an always up-to-date view of your cash position, even down to the day. Tags can track whether cash inflows and outflows are related to operations, financing, or investing.
The ability to understand what the data is saying as quickly as possible gives companies a huge competitive edge and the ability to respond to crises – or unexpected opportunities – as they arise.
Finally, since bank APIs provide a single source of truth there are no data silos – everyone is looking at the same information and making decisions accordingly.
Cash Flow Management – Which Side of the Iceberg Are You On?
Take a look at the cash management iceberg below. There are two different ways of doing things: the traditional way (manually, with spreadsheets) and the modern way (with automation and real-time cash visibility).
Above the water, you see what we get with each method. With manual processes, for instance, your cash flow forecast is “semi-trusted” – it’s alright, enough to give general advice for steering the company ship. But it won’t be enough to direct an exact course, where every bit of liquidity counts and is perfectly allocated.
For that, you need forecasts generated from bank data, refined by machine learning, that becomes increasingly accurate over time.
Daily cash positions are a pain to build. If you’re a large company, it might even be impossible – at the very least, you won’t have enough time in a day to establish your daily cash position by the end of that day. With APIs, it’s right there without any effort required from the treasury team.
Modernize Cash Flow Analysis With Trovata
Every business depends on the successful management of liquidity. Understanding cash flows is the first step.
But to get the clearest insights, analysis must be performed as efficiently as possible. And that means making the leap from one side of the iceberg to the other – from manual to automated processes.
Trovata specializes in helping businesses of all sizes successfully manage their cash flow through powerful automation and modern tools like AI and real-time payments. Book a demo today.
