Cash flow can be best described as the amount of cash and cash equivalents that a business has generated or spent over a specific period of time. Cash on hand determines a company’s runway the more cash on hand and the lower the cash burn rate. The more cash on hand a business has the more freedom they will have to spend and invest in the future of their business.

It is important to understand that cash flow and profit are not the same thing. Cash flow is the money that flows in and out of your business. Profit, on the other hand, is the money you have after deducting your business expenses from overall revenue.

There are three types of cash flow that businesses should track and analyse to determine the liquidity and solvency of their organisation. These three types of cash flow include; cash flow from operating activities, cash flow from investing activities and cash flow from financing activities. All three of these cash flows will be included in a business’s cash flow statement. 

By undertaking a cash flow analysis, businesses compare line items in those three cash flow categories to decipher where all the money is coming in, and where it’s going out. From this, they can reach conclusions about the current state of the business. 

Depending on the type of cash flow, bringing in money in isn’t necessarily a good thing. And, spending money it isn’t necessarily a bad thing.

Cash flow analysis first requires that a company generate cash flow statements about operating cash flow, investing cash flow and financing cash flow.

Cash from operating activities consists of cash received from customers less the amount spent on operating expenses. In this bucket are annual, recurring expenses such as salaries, rent, utilities and supplies.

Investing activities reflect funds spent on fixed assets and financial instruments. These are long-term, or capital investments, and include property, assets in a plant or the purchase of stock or securities of another company. 

Financing cash flow is funding that comes from a company’s owners, investors and creditors. It is classified as debt, equity and dividend transactions on the cash flow statement.

A cash flow analysis will determine a businesses working capital. Working capital is the amount of money an organisation has available to run business operations and complete transactions. That is calculated as current assets (cash or near-cash assets, like notes receivable) minus current liabilities (liabilities due during the upcoming accounting period). 

Analysis of working capital provides a snapshot of the liquidity of the business.

To undertake a cash flow analysis, you must first prepare operating, investing and financing cash flow statements. Generally, the finance team uses the businesses accounting software to put these statements together.

In order to prepare a cash flow statement. The items listed below are factored into the company’s net income and are included on the company’s operating cash flow statement include but are not limited to: 

  • Cash received from sales of goods or services
  • The purchase of inventory or supplies
  • Employees’ wages and cash bonuses
  • Payments to contractors
  • Utility bills, rent or lease payments
  • Interest paid on loans and other long-term debt and interest received on loans
  • Fines or cash settlements from lawsuits

There are two common strategies undertaken to calculate and prepare the operating activities section of cash flow statements.

The Cash Flow Statement Direct Methodtakes all cash collections from operating activities and subtracts all of the cash disbursements from the operating activities to get the net income. The Cash Flow Statement Indirect Method begins with net income and adds or deducts from that amount for non-cash revenue and expense items.

The next stage of a cash flow statement is investing cash flow. That bottom line is calculated by adding the money received from the sale of assets, paying back loans or selling stock and subtracting money spent to buy assets, stock or loans outstanding.

Last of all, financing cash flow is the money moving between a company and its owners, investors and creditors.

The team at Vault are here to help. We offer the full suite of financial products and advice to help you navigate the business landscape. Schedule a meeting here via Calendly or give us a call on 1300 1 VAULT ((07) 3012 6724).