Cash Flow Analysis: All You Need to Know

Cash flow refers to a company's payment streams (various inflows and outflows). The cash flow analysis is a compilation and report illustrating the change in liquid assets over a given period (money in and money out).

For instance, the cash flow increases when the company takes a loan and decreases when a company repays the loan. When calculating cash flow, accounting entries should be disregarded, with focus entirely on the actual inflows and outflows.

As market conditions change, it becomes especially important to monitor cash flow. A pandemic or a slowed economy are examples of risks that could lead to problems. You may need to handle cancelled payments from customers and sudden cost increases in your own purchases.

Therefore, the link to liquidity budgeting and liquidity forecasting is crucial. Essentially, it's about making sure you can handle all outgoings in the day-to-day business.

What does a Cash Flow Analysis look like?

In a cash flow analysis, the company's inflows and outflows during the period (usually the fiscal year) must be reported.

This is done by dividing the analysis into three parts:

1. Operating Activities: Sales, inventory, receivables, short-term liabilities, annual result, and adjustments for depreciation.

2. Investing Activities: Acquisitions and sales of tangible fixed assets and other types of investments.

3. Financing Activities: New issues, paid dividends, group contributions, and raising or amortizing loans.

The breakdown shows how money has moved during the period, where it has come from, and where it has gone. It is important for those reviewing the analysis to be able to assess the relative importance of each cash flow for the company's financial position, liquidity situation, and the interrelationship of the cash flows.

The year's cash flow is the sum of the inflows and outflows in operating activities, investing activities, and financing activities.

How do you perform a Cash Flow Analysis?

Most people use the so-called indirect method to conduct a cash flow analysis. You start with the reported result and adjust for items that do not affect cash flow, such as depreciation, write-downs, and tax.

You then arrive at the cash flow from operating activities before the change in working capital.

With the direct method, you don't start with the income statement, but look directly at inflows and outflows. You calculate the cash flow from operating activities, before paid interest and taxes.

The easiest way to do a cash flow analysis is to start from a template, so you don't miss anything. You also have a lot to gain by using a budget and forecasting tool that supports cash flow analyses.

How should you analyse your Cash Flow?

Positive Cash Flow

Having a positive cash flow (when operating revenues exceed net revenues) is a strong indicator of a company's ability to remain solvent and that the company will grow its business sustainably.

Look beyond your positive cash flow

For example, a positive investment cash flow and negative operational cash flow may signal problems. It may indicate that your company is selling assets to pay for operational costs, which is not always sustainable.

Analyse your negative cash flow

Negative cash flow does not have to be bad. It can be explained by investments you have made. A positive operational cash flow and a negative investment cash flow may mean that you are earning money and spending it to grow.

Operating Cash Flow Margin builds trust

The Operating Cash Flow Margin measures cash from ongoing operations as a percentage of sales revenues during each period. A positive margin shows profitability, efficiency, and result quality.

Calculate your Free Cash Flow

What you have left after you have paid for operational expenses and investments is Free Cash Flow. This can be used to pay down principal amounts, interest, buy back shares, or acquire another company.

Financing Analysis and Free Cash Flow

Shareholders, stock analysts, and investors sometimes talk about cash flow analysis as "financing analysis". The motive behind a financing analysis can make the cash flow analysis look different. For example, investors may want to look at operational cash flow to assess the company's ability to survive.

Shareholders should see cash flow analysis as an extension of fundamental analysis (what a company is worth).

Free Cash Flow is a term often discussed in stock valuation. Free Cash Flow is money that shareholders can do what they want with, is taxed, and can be used for dividends.

Free Cash Flow is calculated by taking the cash flow from the ongoing business (after a change in working capital) and deducting the cash flow from investments.

Free Cash Flow is also a key figure used in stock analysis and aims to show a company's "real profit": What is left over for shareholders in the form of dividends, share buybacks, loan amortisation, liquid assets, or investment in the business.

Free Cash Flow is harder to beautify, unlike the income statement's reported profit, which can be improved with, for example, depreciations.

Why conduct a Cash Flow Analysis?

Most companies that conduct a Cash Flow Analysis do so because it is required by the Annual Accounts Act, but it may be a good idea to seize the opportunity and use the Cash Flow Analysis as a tool to take the pulse of your company, see trends and problems, and make adjustments.

The Cash Flow Analysis also serves as a tool for comparison (also for investors), provides an overview of revenues and expenses and expected future cash flows within a company, possibly in connection with financial scenario planning.

Cash Flow Analysis is also a way for stakeholders, such as lenders and management, to easily understand where the money has gone and how the company operates. Internally, Cash Flow Analysis contributes to increased control over liquidity, and externally, the interest is closer to repayment capacity, financial strength, and future profitability.

For example, the company may be doing well, but there is no money. Then a Cash Flow Analysis is done to find answers such as; large stock, customer receivables, or long credit times. Then a solution could be to take out a loan.

Cash Flow and Risk

Also, consider your risk management and whether it includes cash flow. In rapid crises, problems with liquidity supply are actualised. In addition to managing liquidity-wise everyday life, a crisis can lead to you not being able to afford to make investments.

It is a good idea to strengthen the cash flow and make it more robust. This is done by building a culture ("Cash culture") around liquidity through people, structure and process dimensions according to McKinsey.

Also being aware of risks, analyzing them, and having a responsibility structure around the management of risk and risk culture, helps you secure a sustainable cash flow.

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