Cash Flow Analysis – Understanding The Basics

Written by Blake Mulligan
April 6, 2021

Cash flow analysis is the study of how a business generates and spends money.

Operation costs, financing activities, and investing activities are analyzed and evaluated.  The cash flowing in and the cash flowing out are closely examined and ultimately form the basis of a thorough cash flow analysis.

Cash flow statements portray how a company has spent its cash.  It is usually used in tandem with the balance sheet and the income statement.

Why is Cash Flow Analysis Important?

Thorough and accurate cash flow analysis provides data company cash managers like controllers and treasurers need to be effective and efficient.

Businesses must pay expenses, bank loans, and taxes. In addition, there are assets to purchase. A cash flow analysis determines whether or not a business has enough money to operate and remain solvent. For a business to be successful and run smoothly, it must have sufficient cash flow at all times.

Financial professionals must not only analyze a company’s cash flow, they must also scrutinize their business’s cash position at any given moment.

How is Cash Flow Different from Cash Position?

While closely related, cash flow and cash position have a significant difference.

Performing a cash flow analysis will provide data on the net change in finances over time.

Cash position refers to a company’s relative cash position at a particular moment in time. It reveals the level of cash a company has on its book compared to its pending expenses and liabilities.  Controllers and treasurers tend to focus on cash positions to ensure they have the resources they need to operate daily, but also where they can make material changes to the business.

A strong cash position indicates a business’s liquidity and financial strength. Liquidity refers to how quickly a company can turn its assets to cash with the least impact on the asset’s market price. The faster the asset can be turned to cash, the quicker a business can access the funds to pay off debts and short-term liabilities like rent or payroll.

Without a strong cash position, companies may not have enough cash on hand to pay bills, pay employees, or make important decisions and investments.

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What is a Cash Flow Statement?

A cash flow statement reveals how a company has spent its cash.  It is often used in tandem with the business’s balance sheet and income statement.

3 Types of Cash Flow Statements

There are three types of cash flow statements: Operating Cash Flow (OCF), Cash Flow from Investing (CFI), and Cash Flow from Financing Activities (CFF).

Operating Cash Flow Statement (OCF)

The operating cash flow statement reveals critical information about a company’s cash spending on day-to-day business activities.

An OCF Statement includes:

  • Paid salaries and wages
  • Income tax payments
  • Payments to suppliers for inventory
  • Interest payments
  • Cash received from the sale of goods and services

The OCF provides financial professionals with critical information and insights into the health of the company’s core business or operations.  Companies cannot remain solvent without a positive OCF.

Cash Flow from Investing (CFI)

The cash flow from investing statement provides detailed information on a company’s purchases and sales of capital assets or the cash generated or spend relating to investment activities.

CFI reports then consider the change in the business’s cash position due to profits and losses from investments (like equipment). These items are considered long-term investments in the business.

Investing activities include:

  • Purchasing physical assets
  • Selling physical assets
  • Investments in securities
  • Selling securities

If management invests in the company’s long-term health, negative cash flow from these activities might not be a bad sign depending on the other financials.

Cash Flow from Financing (CFF)

Cash flow from financing activities shows the net cash flows used to fund the company, providing insight into the management of a company’s capital structure.

Financing activities include:

  • Transactions involving debt
  • Equity
  • Dividends

Changes in cash from financing include paying out dividends or raising capital.

How is Cash Flow Calculated?

By using a combination of the cash flow statement, a balance sheet, and an income statement, controllers and treasurers can calculate cash flow.

A balance sheet displays assets, liabilities, and equity. It reflects how much a business is worth. By subtracting all of a company’s assets from its liabilities, controllers and treasurers attain a clear picture of the business’s equity or value.

Similarly, controllers and treasurers use the Income Statement, or profit and loss statement, to display a company’s revenue and expenses. It details how much money the business has earned during the year. 

If the revenue is greater than the expenses, there will be a profit.  If the expenses exceed the revenue, there will be a loss.

By using the cash flow statement, balance sheet, and income statement, financial professionals can ultimately determine if a company is generating enough cash to meet all of its operational needs.

How Can Cash Flow Analysis Be Used to Drive Business Decisions?

In addition to providing information about the liquidity of a company, cash flow analysis can be used to determine if a company will be able to finance its operations without seeking outside funds. Knowing this, a company can prepare to survive during economic downturns or volatile events.

If a company is growing, it may have a negative cash flow from investing and operating activities but a positive cash flow from financing activities as it utilizes funds to grow.

If a company is mature, it will have a positive cash flow from operating activities but may have a negative balance in its investing activities.

If a business is declining, it may show a positive cash flow from operating and investing activities but a negative cash flow from financing activities as it uses funds from its business to pay back investors.

It’s important to remember: if a company is taking on long-term debt, a boost in cash flow and working capital might not be good, as the business may not consistently generate enough capital to pay it off.

Conversely, a large decrease in cash flow might not be a bad sign if the company is using the proceeds to invest in long-term fixed assets.  These types of investments will yield earnings for years to come.

The Bottom Line

Real-time cash flow analysis is critical for businesses operating in a fluid environment.

Download our case study “How Trovata’s Cash Analysis Tech Helps Orbus Stand Out” to learn how Trovata can help you digitally transform your cash flow analysis processes to make quick, data-backed decisions.

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