Why is it important to regularly analyse your business's cash flow? According to Intuit Quickbooks, almost three in five SMEs have experienced cash flow problems, which resulted in many having to turn to expensive bank overdrafts and invoice finance to counteract cash flow constraints. Here we explain what is a cash flow analysis and how to do one.
What is cash flow analysis?
A cash flow analysis measures how much money is being made and spent at any given time. Strong cash flow means your business is operating comfortably within its means. When you’re cash-flow positive, you can pay your bills on time and maintain a good relationship with vendors and other stakeholders. Negative cash flow means your business is being stretched to a breaking point. To perform a cash flow analysis, you need to assess the operating, investing and financing activities of your business during any given accounting period.
Why is cash flow analysis important?
A cash flow analysis shows if your business is adequately capitalised, in other words, it has enough cash to meet its requirements. Having a cash flow analysis makes you better prepared for the unexpected and anticipate periods of increased or decreased demand.
Kaye Sotomi, Co-founder and Director of Chop Chop London, and former guest on the Business Class: Money Minutes podcast was able to navigate an uncertain 18 months using cash flow analysis.
"My cash flow analysis prompted me to negotiate a longer freeze on our repayments of the bounce back loan," says Sotomi. "We bought ourselves more time to ensure we weren’t paying out more cash than we needed to.”
You will have patches when unexpected expenses arise or invoices are paid late. The good news is that our range of American Express® Business Cards has been developed with you, the business owner, in mind. For example, you have up to 54 days to clear your Card balance, so you can keep your money in your business for longer and pay your expenses when it suits your business best¹.
How to analyse cash flow for your business
In order to perform a cash flow analysis, you'll need core financial reports – profit and loss statement, balance sheet and cash flow statement. Take the current assets (receivables, cash and near-cash items) and deduct the current liabilities (supplier payables and any tax, debt or other liabilities due within 12 months). This will provide you with an understanding of your company’s ability to meet its short-term obligations.
Begin with a simple tally of expected inflows (client receipts, loan proceeds, etc.) and outflows (vendor and loan payments, capital expenditures) in a given period. The formula is: current cash balance + inflows – outflows. You can then account for different scenarios and see how they affect the end result. A "sensitivity analysis" helps you understand the best-case and worst-case scenarios for your business's cash flow. What would happen if sales are 20% lower than expected? What happens if the cost of raw materials rises 10% overnight?
“The most important line in a cash flow analysis is the sensitivity analysis," says small business expert Carl Reader. "The sensitivity line is not what an accountant would automatically prepare as part of a good cash flow analysis, but it’s what an entrepreneur needs to have in mind.”
Cash flow analysis example
The cash flow analysis template below shows a business that can meet its liabilities 1.2x over. Typically, though, this should be 2:1 or more to provide some breathing space. The "quick" ratio removes inventory from the equation and, in this example, the business cannot afford to meet its liabilities (0.9:1) from quick cash, for example, cash plus receivables. It is recommended that, in order to remain buoyant, a business should always be looking for a quick ratio of 1:1 or more.
Current Assets: |
|
Cash |
67,845 |
Inventory |
36,827 |
Accounts Receivable |
23,835 |
|
128,507 |
Current Liabilities: |
|
Accounts Payable |
28,948 |
VAT |
49,028 |
Short term loans |
25,673 |
|
103,649 |
|
|
Net Current Assets |
24,858 |
|
|
Current Ratio |
1.2:1 |
Quick Ratio |
0.9:1 |
(source: MAP Ltd)
How to use all this information
Use your cash flow analysis to help decide whether you can:
- Improve profitability through altering the revenue mix, pricing, finding efficiencies or reducing expenditure
- Improve cash collection by developing robust credit control procedures
- Liquidate long-term assets to release cash into the business
- Secure more capital to allow the business to continue to trade and grow
What does all this look like in practice?
“Cash flow analysis allows you to truly understand your core primary costs, your secondary costs and what is just ‘nice to have’" says Sotomi. "If your business is struggling, the first thing you must do is get rid of the 'nice to haves', or at least renegotiate any existing terms. Last year, I renegotiated the margins with our vendors – if it was at 5% I asked for an additional 5% helping us reduce the cost of the product and attract more customers. Cash flow analysis allows you to get into all of the detail in terms of what is absolutely necessary and what isn’t.”
How often should you check your cash flow?
The best cash flow analysis advice for any small business owner is to keep on top of it. Despite feeling a cash flow squeeze, the majority of business owners (54%) are not checking their cash flow forecast on a regular basis, typically just monthly or quarterly - according to Market Finance. You can learn how to check your cash flow weekly with our template here.
“Many businesses allow their hard work in building good cash flow analysis to slip off the radar,” cautions Paul Barnes, Managing Director of MAP, an outsourced finance function for UK creative agencies. “The business becomes vulnerable to suffering wastage in bad or slow debts or unnecessary spend. To avoid that situation, make good cash flow analysis and cash flow management ongoing practices, and use modern technology to streamline the process and reduce the manual input required.”
This ability to prepare for the future is why cash flow analysis is so important – and is just one of the reasons why it should form an essential part of your business practice.
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- The maximum payment period on purchases is 54 calendar days on Gold & Platinum Business Charge Cards and 42 calendar days on the Basic Business Charge Card, it is obtained only if you spend on the first day of the new statement period and repay the balance in full on the due date.
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