Has your company performed a cash flow analysis recently?

One of the wisest measures you can take as a small business owner is to perform a regular cash flow analysis. It’s like having a routine medical check-up. You may not be feeling sick at the moment, but you go for your scheduled physical exam anyway, so you’ll have hard data on the state of your health as well as early alerts if anything is amiss.

It’s the same for a company’s finances. Regularly tracking cash flow gives you the necessary numbers for sound business planning and timely interventions. 

What is cash flow? It is the net balance of cash and cash equivalents that a company has within a given accounting period, which may be a month, a quarter, or a year. 

What makes a cash flow analysis particularly useful is the tangibility and quantifiability of cash. You can measure cash inflows and outflows accurately and with little chance of misinterpretation because money is concrete and countable. For the same reason, a business’s financial situation is also difficult to misrepresent in a cash-based analysis. 

On the other hand, non-cash-based elements in financial analysis can sometimes create, or be made to create, the false impression that a company is doing well when, in reality, it is not. 

Non-cash items (e.g., depreciated equipment, amortization, unrealized gains or losses, stock-based employee compensation, deferred income taxes, and provisions for discount expenses and future losses) are difficult to value. The valuation of non-cash items can often only be arrived at with some degree of guesswork based on experience – not a very reliable measuring instrument. 

While the value of non-cash items does have to be included in income statements to give investors a fuller picture of a company’s earnings, it is the cash flow analysis that provides you with an accurate measure of your business’s liquidity.

There are different types of cash flow, each relevant to a specific aspect of managing a company. They are: operating cash flow, free cash flow to equity, free cash flow to the firm, and net change in cash. These four categories are the components of your cash flow statement for one accounting period.

As the term implies, operating cash flow is the cash flow generated by a company’s regular business activities. These activities include manufacturing and selling products or providing services; excluded are investment activities. 

Operating cash flow tells you whether your business generates enough cash to sustain operations and grow or needs external funding to boost working capital and finance other operations-related and growth-related expenses. The formula for calculating operating cash flow is: Operating Cash Flow = Operating Income + Depreciation – Taxes + Change in Working Capital.

Free cash flow to equity (FCFE) pertains to cash available for distribution to shareholders. This component is calculated as FCFE = Cash from Operations – Capital Expenditures + Net Debt Issued, where Net Debt Issued = New Debt Issued – Debt Repaid. 

Free Cash Flow to the Firm (FCFF), alternatively called Unlevered Free Cash Flow, is the amount of cash from business operations that is theoretically available to all equity and debt holders after capital and operating expenses. 

FCFF is a financial modeling tool used in valuing a business and is calculated using the formula: FCFF = Net Operating Profit After Tax + Depreciation and Amortization – Capital Expenditures – Increase in Non-Cash Working Capital.

Net Change in Cash, also known as Cash Balance, refers to the increase or decrease in net cash for a given period, based on the sum of net cash balances from a company’s operating, investing, and financing activities. If a company transacts in more than one currency, exchange rates on the cash and cash equivalents are factored into the three net cash balances. 

Net Change in Cash is the final category in your cash flow statement. 

To compute your business’s cash flow for the period you are tracking, deduct the opening balance (cash balance at the start of the given period) from the closing balance (cash balance at the end of that period). The difference may be positive or negative, depending on your business’s performance during that period. 

A positive difference indicates that your company ended the given period more liquid than at the start. A negative difference means that the company closed the period less liquid than before, which could be a concern. 

However, if the negative result is due to a growth strategy that will bring future benefits, it need not be that big a problem. This nuance in interpretation is why it’s advisable to do a cash flow analysis at regular intervals. You need to see a trend in your company’s cash flow over time to tell whether your business is doing well or not.

Is your lack of working capital impacting your ability to expand your business?

Because any company’s survival and growth depend heavily on cash flow, monitoring its components through proper working capital management is essential for running a business. Cash flow fluctuations need not become a problem if the causes are analyzed and dealt with promptly. Here are some ways to manage working capital to keep your cash flowing:

Review your company’s past cash flow statements. Go back a few years and see if a pattern or trend emerges for cash flow fluctuations. See what points in the year business seems to slow down or cash flow dips. Identify the factors contributing to the downturns. Distinguish between those that can be managed and those beyond your control. 

Two highly manageable factors that impact cash flow are your accounts payable and accounts receivable, which may seem less significant than other aspects of company operations in the daily rush to get things done. But they do cost money. 

Settle your payables on time to avoid late payment penalties and maintain a clean credit record. Prepare and send invoices promptly to avoid delays in collecting payments. Both measures will contribute significantly to keeping your cash flow steady.

Does alternative business funding make sense for your company?

You could find, from your cash flow analysis, that your company’s cash flow needs can’t be met by internal funding sources alone. Or, you could find that though your cash flow is stable, your company needs extra funding to level up its operations and grow further. In either situation, you may want to think about obtaining external financing for the short term. 

There’s a robust online financing industry out there waiting to offer its services to small businesses like yours. If your business is relatively stable, you could try revenue-based financing. If you prefer a service with lighter requirements, you could try other alternatives like a merchant cash advance. 

Do all that you can to maintain and, whenever possible, increase your company’s cash flow. Cash is every business’s lifeblood. Keep it flowing in yours.