Cash flow analysis: Where is your money going?

  • Published: Sunday, Jan. 13, 2019

Cash is the lifeblood of any business. And it’s especially important in small businesses where company cash resources may not be as vast as that of larger business counterparts. Knowing how cash comes into your business (the sources) and how it exits your business (uses) is key to how successful businesses flourish and why countless businesses fail.

Close up of $100 bills

This is called cash flow analysis.

Cash flow analysis answers two of the most frequently asked questions I hear from businesses with money problems: “How could I have made a profit and still have no cash?” and “Where did all the money go?”

The answers to these two questions are easily answered through an analysis of a cash flow statement, a much needed and less used financial statement of the big three: Profit and loss statement, balance sheet, statement of cash flow.

The statement of cash flow is simply a list of increases and decreases in your account balance on a balance sheet along with net profit or loss, plus any cash withdrawals or injections over a period of time. The key is being able to identify the uses of cash and to match those with sources of cash to generate adequate cash flow with or without additional financing.

To analyze cash flow, you need to understand how to read and understand your statement. There are three categories of cash flow: operating, investing and financing activities. Categorically, the net profit or loss number from the profit and loss statement flows directly to the operating grouping in the statement of cash flow. All other accounts which appear on the cash flow statement are from the balance sheet. Often overlooked, these changes in account balances are frequently the cause of a reduced cash flow for that period.

I recommend that the most time and attention be spent on the operating section of the statement of cash flow.

This group of balance sheet accounts includes accounts receivable, inventory, accounts payable and notes payable in a QuickBooks default format. Many times, I see accounts receivable and inventory as big users of cash, in most cases because the company is experiencing growth. As a company’s sales increase, it is only to be expected that accounts receivable and inventory will increase at least proportionally to sales.

Unfortunately, most companies with industry standard net profits of 2 to 3 percent are not able to fuel substantial sales growth without additional sources of cash. So unplanned sales increases may not necessarily produce cash flow.

Conversely, increases in accounts payable and notes payable may be sources of cash in these instances. Matching short-term sources of cash with short-term uses of cash is crucial. A short-term use of cash usually implies the need will be reduced or paid in less than a year. When companies continue to grow and expand, cash demands typically exceed that time frame.

Here are several tips to increase and improve cash sources on your cash flow statement:

  • For accounts receivable, try restructuring your invoicing or billing procedures to reduce the cycle time of collection and follow it for all accounts.
  • Reducing your inventory by selling off spare parts or items that need to be discontinued generates cash and frees up money to purchase new inventory that can generate additional sales based on the number of times you might sell that item annually.
  • When reviewing accounts payable balances, always consider using the full terms extended to you from your suppliers and look for suppliers with better terms to support your cash flow.
  • Notes payable are short term lending options, typically lines of credit with an annual renewal clause. Make sure you are doing a good job of matching short-term needs with short-term money.

By analyzing your company’s historical statement of cash flow, you can create a cash budget for the future. This knowledge will allow you to project times when you may need additional funds or confirm your ability to make major purchases. Either way, you will have a plan for where your money goes!

– Contributed by Rayanna Anderson, entrepreneurship coordinator and community liaison for MSU’s College of Business and former director of the MSU SBTDC. Anderson writes about issues she regularly sees consulting with small businesses in Springfield and in the state of Missouri.
This article first appeared in the Springfield News-Leader and Used with permission.