In today’s turbulent economy, a financial curveball can throw a business at any given moment. Without adequate preparation, an organization could suffer serious or even fatal damage from unforeseen market shifts, large changes in expenditures, or even unplanned smaller expenses. To better protect against sudden financial demands, companies can utilize cash flow statements as a valuable tool to maintain a clear picture of their financial health.
How Is a Cash Flow Statement Different from an Income Statement?
While income statements simply list total profits against the total losses, cash flow documents include additional financial information along with their operational dates and times. Following the timeline of an operation reveals not only what occurred financially, but also when it happened and when it’s likely to happen again.
By performing a cash flow analysis, businesses are able to map the timeline and movement of financial resources, pinpointing periods of surplus or deficit as they track financial liquidity.
Why Cash Flow Analysis Is Important
Businesses unable to effectively manage their resources could potentially damage their reputation, incur unnecessary fees, have their lines of credit rescinded, or even cripple their credit rating. However, analyzing their cash flow will help recognize when cash will be available, as compared to when bills and payments are due, preventing any late payments to suppliers and vendors.
A cash flow analysis also gives a business an opportunity to review the effectiveness of their current operations. Conducting a study will provide an in-depth overview of a company’s processes, allowing for the business to identify and improve procedures that are either inefficient or unnecessary.
Additionally, an analysis can help a company maintain more consistent solvency. The longer a company remains in the red, or unprofitable, a company is likely to experience crises should unforeseen expenditures arise. By utilizing a cash flow analysis, smart business professionals can eliminate periods of negative liquidity, thus protecting themselves from difficult financial situations.
Finally, companies can predict their fiscal health, operating direction, and status through a cash flow analysis – better forecasting their earnings and expenditures. Business decisions involving investments, mergers, hires, new product lines, and more, can be better analyzed after an accurate cash flow statements have been created.
Three Important Components of Cash Flow Analysis
To ensure a business’s accurate financial picture, cash flow statements should include the following three key components.
- Operating Activities:
- Details the operating cash flow, or the income and expenditures that occur during normal operations. .
- Investment Activities:
- Maps the company’s long-term investment transactions, including buying and selling equipment, assets, property, securities, acquisitions, and similar holdings.
- Financing Activities:
- Accounts for the cash inflow when loans or payments are received and cash outflow when loans are taken out or payments are made.
How to Conduct a Cash Flow Analysis
Businesses have a number of resources available to create a quality cash flow analysis. If they are conducting their own study, there are a myriad of customizable templates online to utilize as a sound starting off point.
For more robust assistance, businesses can employ the help of consulting firms and established companies to guide owners through the cash flow process – as well as offer alternative suggestions to optimize their study.
Additionally, helpful resources may also be available through local community colleges, libraries, city halls, or business networks. Even faculty members at a business college or university may also be willing to offer further assistance.
By connecting to individuals in the business community, a business may be able to attain financial counsel or services for little or no money. In any case, building a business network can lead to relationships or mentorships that could benefit both parties in the future.
Avoiding the Pitfalls of Cash Flow Analysis
When creating a cash flow analysis, there are a few common pitfalls should be avoided.
First, dates and figures need to be as exact as possible. A cash flow analysis is only as helpful as it is accurate. With vague or incorrect information, the analysis cannot elicit the desired benefits nor proper details.
Secondly, a cash flow analysis should be projected as far into the future as reasonably possible. Creating a cash flow analysis that only extends to the next month won’t provide the long-term overview that businesses benefit most from. An effective cash flow analysis details and projects, at the very least, six months out.
Creating a comprehensive cash flow analysis paints a realistic, financial picture for a business. This information is critical to the strategic decision-making process of running a successful company. By proactively mapping cash inflow and outflow, liquidity, recurring fiscal situations, financial projections and more, business professionals can better protect the health of their enterprises and pre-emptively avoid problems.
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