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If you are wondering why you should perform a simple cash flow analysis, the steps you take to complete one and how it can help your business grow, this article will help.

Your monthly accounts payable are going through without a hitch and accounts receivable come in regularly. So, your business is doing well, right?

Whether you run a start-up business or are in a growth stage, a cash flow analysis can tell you a lot about your company’s financial health.

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It is important to realize cash flow and profitability are not the same thing. You can have a profitable business in the long term but negative cash flow at any moment in time.

A simple cash flow analysis explores the movement of money into and out of your company during a specific time period. You can discover whether you need to increase access to liquid assets, spend more in capital investments or reduce spending over the short term.

Understanding business cash flow analysis

A cash flow statement analysis provides a more accurate reflection of a company’s cash position than a profit and loss statement or balance sheet. In addition, a cash flow statement analysis can be used to valuate stocks, determine a company’s true value, help executives decide where cash should be invested and help investors determine whether a company represents a good risk.

Money comes from different sources, so even a simple cash flow analysis will break income into three separate sections:

  • Operating - This shows net income derived from the company’s core business activities. Positive cash flow comes from the sale of goods or services, while expenses such as rent, employee salaries, inventory and income taxes reflect negative cash flow. In general, a business wants to show a positive cash flow in this portion of the cash flow statement analysis.
  • Investing - This summarizes monies received or lost through investments, as well as money spent on investments into the business, i.e., property, manufacturing plants and equipment. These capital expenditures, commonly known as CapEx, may send this portion of the cash flow statement analysis into the red, but that is not necessarily a bad sign. It is better to show a business is earning money through operations and spending money on scaling the business. Companies can show positive cash flow in this area by selling off investments, which could be a red flag for investors.
  • Financing - This last section of the cash flow statement reflects cash derived or spent through equity or debt. It will reveal if a company is using credit responsibly, however, showing negative cash flow in this area is not necessarily a bad thing. It could mean the company is paying down debt or is paying out dividends to shareholders. On the other hand, a positive cash flow from debt could mean the business has incurred too much debt. Companies can also show cash flow in this section by issuing stocks. If too many stocks are issued, stock prices may drop, which is not good for investors. A hefty sale of stocks could indicate the company is not on strong financial footing and needed fast cash.

By analyzing the three elements of a cash flow statement, investors, shareholders and other stakeholders within or outside the company can determine a company’s overall financial health. Stakeholders want to see income derived primarily from operations, with that capital going back into the business in the form of investments in equipment, infrastructure, property, and other elements that can help a company grow.

How to conduct a cash flow analysis

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From the three sections in a cash flow statement, analysts can uncover insights about a company that a simple profit & loss statement may not reveal. The advantages of a cash flow analysis include the ability to see if a company has positive or negative cash flow, how the business is making its money and if the company is reinvesting that money back into the business.

When you first learn how to analyze a cash flow statement, you can follow a series of steps until the process becomes intuitive:

  • Compare operating cash flow with net sales to see how much cash is derived from sales
  • Calculate the free cash flow (FCF), by subtracting capital expenditures, dividends and stock buybacks from operations cash flow
  • Divide free cash flow by net operating cash flow to determine the comprehensive free cash flow ratio, which shows how much money is derived from operations versus how much is being spent on investments and financing

As part of an advanced cash flow analysis, each of these figures reflects a company’s overall financial health. Investors and stock analysts look for a company with a high free cash flow as indicative of a company with a strong future.

What constitutes a “good” free cash flow varies between industries and even individual companies. It is important to do a comparative analysis to determine if FCF is rising, or at least staying the same, each quarter.

Why is a cash flow analysis important?

A cash flow analysis can help show you the next best steps to take for your business. If your cash flow is low, you may consider negotiating trade terms with some of your vendors or even tightening trade terms for clients, so money comes in faster.

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If you have enough inventory, you may slow down on purchases until cash flow improves. If your cash flow is weak but you see pending payments on your balance sheet, you may consider securing short-term financing to get you through until payments start coming in.

Interest-free financing from American Express® can help you manage cash flow by providing up to 55 interest-free days* when you work with your providers to have payments post to your account immediately after your closing date. You do not have to make the payment until your next bill comes due, helping you free up working capital.

If you have a lot of cash on hand, you might be in a good position to invest in your business—or hold onto those cash reserves if you know a slow season is approaching.

Knowing how to do a cash flow analysis is crucial to keeping your company out of bankruptcy, preparing for future growth, and knowing when to save or invest. Any size business can reap the benefits of cash flow analysis if they are prepared to take steps to modify expenditures based on their findings.

Perhaps one of the biggest advantages of cash flow analysis is the ability to spot trends in your company’s health. If you are just starting out, it is best to run a monthly cash flow statement analysis to compare your growth month over month. A monthly cash flow analysis can help you spot seasonal trends so you can save money during busy times to be prepared for slower periods. In addition, it can also help you gauge the best times to buy equipment or make other capital expenditures.

As your business grows, you may want to shift to a quarterly cash flow analysis to save time. You will be able to discover trends that could point to trouble and act accordingly, without spending hours poring over largely predictable numbers each month.

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It is also a wise idea to do a cash flow analysis after a period of rapid growth, an acquisition, a large purchase or any time you have made a major change in operations. You will be able to tell, at a glance, how your company affected your cash flow and make smarter decisions about your next best steps.

* As a charge card, the balance must always be paid in full each month in which no interest charges will apply. The interest free grace period is 28, 29, 30 or 31 days from the closing date of the current statement to the closing date of the next statement depending on the number of days in the calendar month in which the closing date occurs. The number of interest-free days varies based on a variety of factors, including when charges are posted to your account, whether your account is in good standing, and the closing date of your statement.


Content produced by American Express Canada. The Globe and Mail was not involved in its creation.

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