We’ve all heard the expression – “Cash is King.” But why? And more importantly, how do we know if we have enough cash to be king?
The answer is hidden in a financial statement report your accounting team is already producing (or should be producing) – the Cash Flow Statement. We previously discussed the benefits of forecasting cash flow in our article 3 Primary Benefits of Cash Flow Forecasts. Today we’re going to show how analyzing the Cash Flow Statement shows the health of your (or any) company.
Cash Flow Statement Fundamentals
There are a few terms you need to know to analyze your statement.
Terms for Where It’s Going:
- Outflow – all the money that goes out the door.
- Inflow – all the money coming in the door.
Terms for How It’s Being Spent:
- Operating Activities – money used or obtained in core business activities, i.e., day-to-day operations.
- Investing Activities – money used or obtained in buying and selling income-producing assets, i.e., stocks, other companies, etc.
- Financing Activities – money moving between the company, its owners, and creditors, i.e., servicing debt, dividend payments, or stock repurchases to satisfy investors.
The inflows and outflows in the company’s activities help reconcile the non-cash numbers on the income statement and balance sheets (like accounts receivable or depreciation) when the accrual method of accounting is used. The accrual method of accounting records income and expenses as they are incurred rather than when the cash is received or goes out the door. This can result in a company having a profit on paper and being cash poor.
For example, a company might sell a service like paving a driveway generating an account receivable account to be paid once the service has been performed. This creates income (yay), but no cash has been received yet.
What to Look For – A Healthy Cash Flow
When cash flow is positive, more cash is coming in from sales than going out for expenses. Seems simple enough. However, the accrual accounting method makes seeing if cash flow is positive or negative a little murky for some businesses.
Thankfully, most accounting and bookkeeping software does the heavy lifting for us. The primary indicator for healthy cash flow has a “Net Increase in Cash” rather than a “Net Decrease in Cash.” The preferred format of the statement used by the preparer may vary slightly, but you’ll generally find the Net Cash flow toward the bottom of the Cash Flow Statement.
Great. We’ve determined if your company’s incoming cash exceeds or falls short of your expenses. Now what?
The fun part. The analysis!
Score – Net Cash is Positive!
Congratulations! You’ve succeeded in one of the hardest parts of maintaining a business. Time to sit back and relax… well, sort of.
If you’re in this optimal situation, you’ll want to look at your trends. Is this the beginning of your cash exceeding expenses? Have your cash inflows been steadily increasing? The answers will determine your short and long-term strategies. If you’re at the beginning of your boon, you may want to keep the status quo for a period before investing in any changes. It might be time to discuss investing further in your business if you’ve been steadily increasing your positive cash flow. Investments to consider could include hiring employees, buying equipment, or even trying a new product!
Sigh – Net Cash is Negative.
Don’t despair yet. Whether or not it’s time to panic should wait until you evaluate why you have negative cash flow.
Again, it’s all about trends. A heavy investment in the prior period could require some recovery time. There might be a “timing issue” where you’ve billed a customer for a hefty invoice and are waiting to be paid. This could be a good time to review your payment terms to see if you need to shorten the times you are offering to your clients.
Negative cash flow doesn’t necessarily mean you don’t have enough cash on hand. However, it could be an indicator of problems ahead. Now would be an excellent time to review your operating expenses and the cash flow trend. You’ll be able to determine if there are cash shortages on the horizon and if your company needs to make changes in spending.
How to Boost Cash Flow
The best way to boost cash flow is to implement best practices for receivables. In the receivables department, ensuring billing is at its best by:
- Invoicing quickly
- Make payment easy for clients
- Utilize technology for auto-debiting payments and sending reminders
- Regular process of receivables review (weekly is best) by the accounting personnel
- Following up with slow paying customers on a weekly basis
Other short-term options include liquidating inventory and financing.
How We Help
For some of our clients, factoring is an excellent option to bridge the timing gap between negative cash flow and paying out expenses. Factoring offers cash now using a simple process to liquidate accounts receivable. We help our clients access factoring and other financing options to fit their specific situation.
At Liquid Ally, our goal isn’t just to assist our clients in finding the best financing option. We want to empower our clients with understanding and taking control of their company’s financial situation. Our long-term goal is to return your business to a sustainable, healthy cash flow. Schedule a Complimentary Liquidity Assessment today to see how we can assist you with your cash needs.