When analyzing cash flow, review operating activities, capital expenditures, and debt servicing.

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A lack of control over cash flow is one of the leading causes of small-business failure.

 

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Here’s what to look for when analyzing your business’s cash flow.

As any small-business owner knows, maintaining a positive cash flow is the essence of staying on course with your objectives. Conducting a periodic cash flow analysis will help you determine whether your business generates enough cash to meet your obligations and how cash outflow compares to incoming revenue from sales. Cash flow analysis also is used to forecast changes in your receipts and disbursements and to gauge the effects of those changes on future cash requirements.

The Cash Flow Statement

The cash flow statement reports your business’s sources and uses of cash during a specified accounting period (e.g., monthly, semiannually, or annually). When used in conjunction with an income statement and balance sheet, the cash flow statement provides a comprehensive picture of your company’s liquidity. The cash flow statement adheres to Generally Accepted Accounting Principles (GAAP) and is divided into three fixed categories:

  • Operating activities: The change in cash resulting from routine activities that either generate or require cash. This includes incoming receipts (cash and checks) from the sale of goods and/or services, as well as interest and dividend income. Operating activities also include outgoing payments for materials, employee salaries, taxes, insurance, loan repayments, and rent. The net amount of cash from (or used by) operating activities is the most important figure on the cash flow statement.
  • Investing activities: The change in cash resulting from actions or events that involve the purchase or sale of company assets (e.g., securities, land, buildings, or equipment). Investing activities also include paying or collecting on loans.
  • Financing activities: The change in cash resulting from payments to or receipts from suppliers of money to the company. For instance, money borrowed in the form of a loan represents cash receipts, while the repayment of loans or dividends to investors represents cash payments.

What Do the Numbers Mean?

When examining a cash flow statement, there are a few questions to examine closely:

  • Has the company generated cash from operating activities? If not, look at which components of your working capital are using the most cash and try to determine what might be happening. For instance, if your company recently bought out another company’s inventory, the acquisition would explain the additional cash needed. While cash expenditures such as this are not negatives, it is critical to monitor where cash is going.
  • Has there been a significant change in incoming or outgoing cash flow from investing activities? Do the numbers shed light on problems that may be developing within the business? For example, if capital expenditures have been reduced, might it be the result of bank constraints or pressure from creditors?
  • How much debt has been paid or borrowed? This question reveals unusual financing activities that have not been highlighted elsewhere in the analysis.

In the final analysis, the cash flow statement provides a valuable perspective on your overall financial picture.


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June 2012 — This column is provided through the Financial Planning Association, the membership organization for the financial planning community, and is brought to you by D3 Financial Counselors, a local member of FPA.