What Is Cash Flow and How to Analyze It

Whether you’re a small business owner or run a large corporation, there are three essential financial statements that must be on your radar at all times. These are the income statement or profit and loss statement, the balance sheet, and the cash flow statement. 

All of these documents reveal valuable details about the financial health of the business and are key for financial planning, decision-making, and business growth.

Although all three are considered fundamental for companies, some believe that the cash flow statement is king. 

In short, cash flow refers to how cash equivalents or cash moves in and out of a company over a specified period. It is vital for financial reporting and indicates the business’s liquidity and ability to meet financial obligations now and in the future.

In the following sections, we dive deeper into cash flow to explain what it is, how to calculate it, why it matters, and more. 

Understanding Cash Flow

As mentioned above, cash flow shows money coming into the business and money leaving the business in the form of income or expenditure. 

Although often confused as the same thing, cash flow and profit are very different. While profit is an accounting measure that shows the amount of money left after expenses have been paid, cash flow represents actual cash available for use. 

No matter what type of business you’re involved in, money flows constantly. For instance, businesses use the money the company generates to pay for new inventory, new equipment, raw materials, or other physical assets. At the same time, cash payments could be coming into the business as a result of deals with partners or sales. 

One of the most important things to understand about cash flow is the key concepts of positive and negative cash flow.

Key Cash Flow Concepts

Different companies have different cash flows. Some could be positive, while others can be negative.

In essence, positive cash flow means that more money is coming into the business than leaving. A positive net cash flow is the best-case scenario for businesses as it shows that the company has enough money to cover expenses and plan for the future.

On the other hand, negative cash flow shows that more cash is leaving the company compared to money coming in. When cash coming in is less than cash going out, there are serious reasons for concerns related to financial distress and instability. 

However, this should not always be considered alarming. Poor cash flow can be a consequence of business expansion. This may mean a lot of money moving out of the company at the present only to create more opportunities in the future.

Types of Cash Flow

The core concepts are not all that you should know about cash flow.

There are also different types of cash flow, all equally important:

• Operating Cash Flow (OCF) – Represents cash generated from core business operations like sales and services. OCF excludes cash flows from investments or financing.
• Investing Cash Flow – Cash a company spent or earned from investing activities or buying or selling current assets like equipment or marketable securities. Investing cash flow usually results in negative cash flow due to investments in growth.
• Financing Cash Flow – Cash flow from financing activities or cash transactions involving debt, equity, and dividends, such as issuing stock or repaying loans.

After you’ve figured out all three types of cash flow, you can either add them to or subtract them from your beginning cash balance to discover your overall net cash balance. 

We’ll talk about this in more detail later on in this article when explaining how to calculate cash flow. 

The Cash Flow Statement

Now that we’ve covered the basics, let’s move on to the cash flow statement. 

What purpose does it have and what does a cash flow statement look like?

We answer all of these questions below.

What’s The Purpose of a Cash Flow Statement?

Overall, a cash flow statement is a financial statement that outlines a company’s cash inflows and outflows over a specified period. 

It determines how successful a company is at managing its cash position or how well it generates cash to cover obligations and support operating expenses. 

The cash flow statement is just as important as the income statement and balance sheet. In fact, it complements it for a comprehensive financial view and helps businesses plan ahead.

The Structure of a Cash Flow Statement

Typically, in a cash flow statement, you’ll see three core sections – cash flow from operating activities, investing activities, and financing activities.

Operating activities

Cash flow from operating activities is your net income, along with increases or decreases in current assets, liabilities, and expenses. 

In a nutshell, this is the cash from day-to-day business operations. This includes cash receipts, cash paid to suppliers, wages, interest payments, rent, income tax payments, and more. 

Keep in mind that changes made in cash, accounts receivable, depreciation, inventory, and accounts payable are usually reflected in cash from operating activities. 

Investing activities

Cash flow from investing activities, on the other hand, is cash used in or generated from buying or selling physical or financial assets. For example, cash received from selling company equipment is cash flow from investing activities. 

Investing activities reflect rises or drops in long or fixed-term assets, regardless of accumulated depreciation.

Financing activities

Finally, cash flow from financing activities is cash raised or spent through loans, equity, or dividend payments. 

In simple terms, financing activities represent the net flows of cash used to pay for the company and its capital. For instance, this could be cash received from issuing stock or debt. It could also be cash spent to repay debts or purchase back stock. 

Analyzing Cash Flow

The good news is that you don’t have to be an experienced accountant to analyze cash flow.

Instead, there are a few easy steps to consider.

First, start by reviewing your company’s cash flow statement.

Look carefully at the cash flows across the three core sections we mentioned above – operating, investing, and financing activities. Explore the recorded money coming in or going out of your company.

Next, calculate the net cash flow. You can do so by taking out your total cash outflows from the total cash inflows.

* Net Cash Flow = TCI (Total Cash Inflow) – TCO (Total Cash Outflow)

The Net Cash Flow will ultimately reveal the liquidity of your company during a specific period. You can use this information to make comparisons against previous periods. 

In some cases, you’ll be able to quickly spot trends that will show you whether your cash flow is improving or, on the contrary, is getting worse. 

Key Indicators of Cash Flow Health

But even after you’ve analyzed your cash flow, how can you tell whether your cash flow is healthy or needs improvement?

The following three elements are certain signs of a healthy cash flow:

• Consistent positive operating cash flow –  Shows operational efficiency and profitability
• Negative investing cash flow – Normal for growing businesses investing in assets
• Stable financing cash flow – Suggests balanced use of debt and equity financing

If after analyzing your cash flow you’ve discovered these indicators, there’s no need to worry.

However, oftentimes, companies find themselves in challenging situations regarding cash flow. Below, we share a few popular cash flow challenges and suggest strategies to improve cash flow management. 

Common Cash Flow Challenges

Even if your company is performing great during a specific period, it could still have cash flow issues. 

Let’s look at some of the most popular cash flow challenges both small and large companies face. 

Poor Cash Flow Management

For starters, there are always risks of poor cash flow management. 

This is usually a result of inefficient invoicing, late payments, or uncontrolled spending that puts a burden on the financial stability of the business.

Usually, companies with poor cash flow management tend to find meeting financial obligations challenging. In some cases, this means an inability to be consistent with payroll or supplier payments. 

In the long term, this can cause additional problems that could prove to be detrimental to the company. 

Payment Delays

Another frequently seen obstacle related to cash flow is late payments from customers or partners.

Receiving expected payments late can dramatically disrupt cash flow forecasts and can even pause normal operations. Without strict regulations and agreements in place, payments can sometimes be months late, seriously affecting the company’s liquidity and ability to spend. 

One of the best ways to avoid this is to implement clear payment terms and penalties for late payments. This can strongly incentivise your clients to pay on time, improving your cash flow. 

Over-investment in Inventory or Assets

Another potential cash flow challenge could stem from excessive spending on expensive inventory or fixed assets. Such activities can significantly reduce the available cash the company has access to, potentially creating issues.

To avoid this, it’s highly recommended to improve your inventory management and put in place adequate capital expenditure plans. 

Improving and Managing Cash Flow

But what if your business finds itself in one of the previously mentioned scenarios?

What can you do to improve and manage cash flow better?

Here are a few tested and proven suggestions. 

Strategies for Positive Cash Flow

The first thing you could do is optimise your existing payment terms. 

Have clear and structured conversations with your customers and partners about payments and make sure you’re all on the same page. You can even motivate clients to make early payments by offering attractive discounts or other incentives. 

If you notice that a supplier isn’t comfortable with short payment terms – don’t be afraid to suggest longer alternatives. By doing so, you’ll have peace of mind knowing that you’ve avoided payment delays and your payments will always be on time, allowing you to plan ahead and make accurate forecasts. 

Next, make sure that you’re consistently monitoring cash flow. Rely on advanced financial reporting tools that give access to real-time cash flow visibility. This will allow you to be one step ahead at all times.

In addition, detect areas where you can cut down on costs, if possible. If you’ve identified that there is excess spending that’s sometimes unnecessary within your company, brainstorm ways to cut these expenses to improve cash flow. 

Finally, you can consider counting on financing options like credit lines or loans to cover short-term cash gaps. 

Tools for Cash Flow Management

Luckily, today there are plenty of effective tools that you can use in order to enhance your cash flow management and see better results.

For example, you could invest in accounting software that lets you track inflows and outflows, generates reports, and puts you in control. Having reliable, easy-to-use invoicing systems, like POS invoicing, can also result in impressive improvements.

Moreover, there are sophisticated tools for cash flow forecasting that can come in handy. These solutions are designed to project future cash positions to offer extra reliability when it comes to decision-making. 

Final thoughts 

Overall, cash flow is incredibly important for any business, no matter the size or the niche. 

Ensuring a stable cash flow can help you guarantee liquidity to meet short-term obligations. It can also enable long-term growth via investments in diverse assets or by creating opportunities for expansion. 

Understanding this fundamental measure of financial health will allow you to make informed business decisions and remain solvent, plan for growth, and mitigate risks.

Frequently Asked Questions

What do cash and cash equivalents mean?

Cash and cash equivalents are cash, petty cash, bank accounts, and investments that are short-term and highly liquid. For instance, these could be Treasury bills, short-term government bonds, and others.

How is free cash flow calculated?

Free cash flow represents how much cash the business has after it has covered all its expenses and obligations. You can calculate free cash flow by adding your net income and non-cash expenses and subtracting the change in working capital and capital expenditure.

Is cash flow the same as profit?

No, cash flow is not the same as profit. Cash flow represents the movement of money in and out of a business, while profit shows the financial gain (revenue minus expenses) on your income statement.