How to Analyze Cash Flow Reports

How to Analyze Cash Flow Reports

Know exactly what resources you have at any given moment.

Cash flow reports provide critical insights and information into a business’s financial health. Entrepreneurs, business owners, investors, and working professionals use them to make important business decisions about properly utilizing company resources. 

Cash flow analyses help these decision-makers answer important questions, time their business moves, and optimize cash flow to keep the business afloat. Ultimately, understanding how to properly analyze cash flow reports is foundational to business success.

That’s why, in this article, we’ll take a deep dive into cash flow reports, discussing their importance and providing essential techniques you can use to calculate and optimize your business’s cash flow.

Why Are Cash Flow Reports Important?

Cash flow is the lifeblood of any business. Without it, the business cannot exist. 

Cash flow reports are important because they allow us to gauge the “life expectancy” of the business and use that information to better allocate company resources.

Similar to how a doctor diagnoses a patient, cash flow reports help us diagnose and treat cash flow problems in both the short-term and the long-term before they become catastrophic.

For investors, these insights can spell the difference between making a significant investment and moving on to something else. 

For the entrepreneur or CEO, they can provide crucial guidance based on historical data into their business’s next best move.

And, for the manager, cash flow report analyses help to manage budgets, employee workloads, and relationships with company leadership more efficiently. 

It’s worth noting that cash flow is not the same as profit. For this reason, a cash flow statement shouldn’t be interpreted as the sole indicator of a company’s financial health. 

Rather, it’s best when paired with additional financial information, including income statements and balance sheets. 

The Basics of a Cash Flow Statement

To analyze a company’s cash flow, you first need a cash flow statement. 

This displays all cash inflows from current operations and external revenue sources, in addition to all cash outflows that cover business expenses over a certain period of time.

Every cash flow statement illustrates the following:

• Cash flow from operations (CFO): This lays out cash flow from your company’s income statement, such as accounts receivable, accounts payable, and payable income tax. If your company receives a payment, it gets recorded as cash from operations. Changes in current liabilities or assets are also recorded under this category.
• Cash flow from investing (CFI): This encompasses cash flow from capital expenditures and the sale of long-term investments, including property, equipment, and other fixed assets like furniture, vehicles, or buildings. Other potential cash outflows include investment securities and other business acquisitions. 
• Cash flow from financing (CFF): This section provides information on your business’s debt and equity transactions, including dividend payments, the sale/repurchase of bonds and stocks, and loan payments. Investors who prioritize dividend payments from their investments often pay close attention to a business’s CFF report.

Next, let’s take a look at the different tactics and techniques that go into calculating cash flow.

How to Calculate Cash Flow

There are two basic methods for calculating cash flow:

• Cash flow statement direct method: The direct method reflects the transactional information that impacted a business’s cash flow during a set period of time. Simply subtract any cash disbursements from cash collections.
• Cash flow statement indirect method: The indirect method reflects revenues and expenses incurred at times outside of when cash was paid or received. This means that cash flow from operating activities will sometimes differ from net income, as some transactions may still have to clear.

The method you choose will depend largely on what details are most important to you. The direct method lets you see cash inflows versus outflows more clearly, which is useful for short-term planning. 

On the other hand, the indirect method shows why your net profit may be different from your closing bank position, which helps you know exactly how much cash you’re actually working with at any given time.

Conducting a Cash Flow Analysis

The figure at the bottom of your statement indicates your company’s cash flow, often labeled as “net change in cash account” or “ending cash balance.” This is the net cash amount from each of the three sections mentioned above (financing, operations, investing). 

A simple cash flow analysis involves looking at the statement, evaluating whether cash flow is net negative or positive, and comparing outflows to inflows.

Businesses often use several metrics in cash flow analysis. 

Here are a couple of the most common:

• Operating cash flow/net sales illustrate how many dollars of cash the business generates for every dollar of sales, which is expressed as a percentage of net operating cash flow to net sales/revenue from the income statement. In general, the higher the percentage, the better. There can be quite a bit of variation in this ratio, so it’s essential to look at historic performance and see how well the company performs against its competitors.
• Free cash flow is your net operating cash flow minus capital expenditures. This is a crucial statistic because it reveals the business’s efficiency in generating cash. Investors typically pay close attention to this because it indicates how much cash the company will have to pay investors through share buybacks and dividends. As with operating cash flow, it’s always useful to compare performance over multiple quarters and to your peers in the industry. If this figure is consistently positive, it often means that customers, employees, and investors can rely on you to meet your financial obligations. 

These two metrics can be combined to give a more comprehensive picture of cash flow—divide free cash flow by net operating cash flow. As always, the higher the percentage, the better.

What Can a Cash Flow Analysis Teach Us?

Cash flow analyses are the windows that let us see a given company’s financial stability or instability.

Here are a few terms to keep in mind:

• Positive cash flow. This is your goal. If you have positive cash flow over an extended period of time, you show that your business can operate efficiently and grow consistently. But, digging into this a little deeper, note when you have positive investing cash flow and negative operating cash flow. This could indicate that cash from the sale of Investments is going towards operating expenses, a potentially dangerous sign for long-term growth.
• Negative cash flow. While positive cash flow is always the goal, negative cash flow may not always indicate trouble. You may find yourself slipping into negative territory if you need to use resources to improve your products and streamline your operations.
• Free cash flow. This is the cash flow remaining after you’ve purchased necessary capital assets and paid off operating expenses. It’s a great tool to have at your disposal, one that you can use to pay dividends or interest to investors, pay down debt, and much more.
• Operating cash flow margin. This compares cash from operating activities to sales revenue. When it’s positive it demonstrates that your business can convert sales to cash, which tends to show profitability.

When you can accurately read these indicators, you get a very clear picture of the state of your business. Are you a mature company that shows long-term profitability or a speedy startup growing faster every day?

Optimize Your Cash Flow With Help From Avior

Of the many financial documents necessary for your business, cash flow statements are among the most critical for successful day-to-day operations. 

When you’re able to easily read a cash flow statement, you capture essential accounting skills that allow you to make effective administrative and investment decisions, helping you decide whether you’re in a period of growth, decline, or simply going through a transition.

Avior Wealth Management has nearly a century of experience creating and analyzing financial documents, including cash flow reports. Our advisors can help you select which cash flow analysis method to use and how to use its insights to grow your business accordingly. 

Reach out to one of our team members to get started with a one-on-one consultation.

Disclaimer: Nothing contained herein should be construed as legal or tax advice. Avior and our Advisors will work with your attorney and/or tax professional to assist with your legal and tax strategies. Please consult your attorney or tax professional with specific legal and/or tax questions. Investment Management and Financial Planner are offered through Avior Wealth Management, LLC, an SEC-registered investment advisor. Past performance is not a guarantee of future results.  Investments are subject to loss, including the loss of principal.