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Understanding Cash Flow Analysis

A cash flow statement is one of the most important financial statements for a project or business. The statement can be as simple as a one page analysis or may involve several schedules that feed information into a central statement.

A cash flow statement is a listing of the flows of cash into and out of the business or project. Think of it as your checking account at the bank. Deposits are the cash inflow and withdrawals (checks) are the cash outflows. The balance in your checking account is your net cash flow at a specific point in time.

A cash flow statement is a listing of cash flows that occurred during the past accounting period. A projection of future flows of cash is called a cash flow budget. You can think of a cash flow budget as a projection of the future deposits and withdrawals to your checking account.

A cash flow statement is not only concerned with the amount of the cash flows but also the timing of the flows. Many cash flows are constructed with multiple time periods. For example, it may list monthly cash inflows and outflows over a year’s time.  It not only projects the cash balance remaining at the end of the year but also the cash balance for each month.

Working capital is an important part of a cash flow analysis. It is defined as the amount of money needed to facilitate business operations and transactions, and is calculated as current assets (cash or near cash assets) less current liabilities (liabilities due during the upcoming accounting period). Computing the amount of working capital gives you a quick analysis of the liquidity of the business over the future accounting period. If working capital appears to be sufficient, developing a cash flow budget may not be critical. But if working capital appears to be insufficient, a cash flow budget may highlight liquidity problems that may occur during the coming year.

Most statements are constructed so that you can identify each individual inflow or outflow item with a place for a description of the item. Statements like Decision Tool Cash Flow Budget (12periods) provides a flexible tool for simple cash flow projections. A more comprehensive tool for a Farm Cash Flow (Decision Tool) is also available. A more in-depth discussion of creating a cash flow budget is Twelve Steps to Cash Flow Budgeting.

Some cash flow budgets are constructed so that you can monitor the accuracy of your projections. These budgets allow you to make monthly cash flow projections for the coming year and also enter actual inflows and outflows as you progress through the year. This will allow you to compare your projections to your actual cash flows and make adjustments to the projections for the remainder of the year.

Reasons for Creating a Cash Flow Budget

Think of cash as the ingredient that makes the business operate smoothly just as grease is the ingredient that makes a machine function smoothly. Without adequate cash a business cannot function because many of the transactions require cash to complete them.

By creating a cash flow budget you can project sources and applications of funds for the upcoming time periods. You will identify any cash deficit periods in advance so you can take corrective actions now to alleviate the deficit. This may involve shifting the timing of certain transactions. It may also determine when money will be borrowed. If borrowing is involved, it will also determine the amount of cash that needs to be borrowed.

Periods of excess cash can also be identified. This information can be used to direct excess cash into interest bearing assets where additional revenue can be generated or to scheduled loan payments.