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Consider two organizations for a cash flow analysis example. They display identical net profits for a given year. Does that mean they have identical cash positions and similar cash flow stress? A cash flow analysis may reveal a huge difference between the two as net profit is not the measurement of the amount of cash that comes in or is spent. Managers and entrepreneurs have to put equal emphasis on cash flow statement analysis to identify areas of strengths and weaknesses when expanding a business.
Let’s clearly understand the concept of cash flow and how it differs from net profit. Consider the cash flow statement analysis example of Violet Inc. In 2019, they earned revenue of $1,000 and recorded their expenses at $600. In general terms, we conclude that the organization made a net profit of $400. However, despite having $1,000 revenue, they collected only $800, with the rest set to be collected the following year. Subsequently, they paid $500 for expenses that year. Now we see that even though Violet Inc made a profit of $400 their net cash inflow was $300 in 2019.
What Is Cash Flow Analysis?
Cash flow analysis is a tool to better understand how much cash an organization has at a given time and where the money is going. It’s a financial statement generated during a specific and predetermined time period that records money flowing in and out of a business. To ensure a healthy cash budget, it should be ideally done once a month or more frequently, if need be. Any cash flow analysis example can show why managers need to regularly perform it if they want to be successful. Cash shortage is a common cause that drives businesses to failure, especially small firms. A regular cash flow statement analysis can avoid such pitfalls and help managers meet objectives effectively.
The most fundamental aspect of cash flow analysis is the cash flow statement. Studying a cash flow analysis example shows that organizations have to generate statements for cash related to operations, investments and financing.
The difference between the amount received from customers and that spent on operating expenses represents the cash from operating activities. These are recurring or annual expenses such as rent, salaries, supplies and other utilities.
Cash from investing activities represents the money spent on financial instruments and fixed assets. Long-term capital investments such as purchasing stocks, property or assets in a plant are all used to prepare an investing cash flow statement.
Financing cash flow statements reflect funds that come in by recording equity, debt and dividend transactions. It’s the cash that moves between an organization’s investors, creditors and owners.
The key to a healthy business is monitoring cash flow effectively and periodically. Now that we know the basics of cash flow analysis, let’s see why it’s important.
- A cash flow statement analysis example can show how it presents a well-rounded picture of the financial health of a business. It determines whether cash flow is regular and whether there’s a shortage or surplus
- An analysis can identify how and why a business may fail to meet expenses such as salaries, consignment costs and supplier costs. It offers the opportunity to cut costs, find ways to accelerate income and obtain short-term financing
- If an analysis makes managers aware of surplus in-hand cash that they can invest in new equipment, expand operations or make savings for predicted market slowdowns
Managers and entrepreneurs must know cash flow statement analysis to determine the steps they need to take to meet their targets. An organization with strong profit margins may run into trouble if they don’t have enough cash to pay bills, while a business in debt may rest easy knowing that the projected cash flow can be relied upon to pay debts off.
Indicators In Cash Flow Statement Analysis
A cash flow analysis example will reveal that once cash flow statements are prepared, a manager must lookout for the following indicators to determine how healthy the cash flow is:
- A good cash flow statement analysis example will show that a business can remain solvent and grow its operations sustainably if operating income exceeds net income
- Negative operating cash flow and positive investing cash flow is an indication that the organization may be selling assets to pay operating expenses
- We can see from any cash flow analysis example that negative cash flow could mean that an organization is making enough money and spending it on equipment and innovation to grow
- Free cash is the money left after paying for operating and capital expenditures. This money is used to pay interests, buy back stocks or acquire other businesses
In cash flow analysis, free cash flow is essential as it acts as an evaluative indicator for investors. It reflects the positive qualities of an organization’s operations by highlighting the cash produced internally.
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