Cash Flow Analysis

Cash Flow Analysis

Understanding Cash Flow

To be competitive, small business owners must plan and prepare for all future events and market changes.Possibly the most important aspect of preparation is effective cash-flow planning.Failure to properly plan cash flow is one of the leading causes for small business failures in the United States.

Experience has shown that many small business owners lack a general understanding of accounting principles.For this reason, a few of the basic principles will be covered.There also are self-instructional guides from which you can obtain a better understanding of accounting.

The Basics

Cash in business serves several purposes.First, it is used for meeting normal cash obligations (i.e., paying bills).Second, it is held as a precautionary measure for unanticipated problems.Third, it is held for potential investment purposes.The term “cash” refers to:

  • Cash
  • Checks
  • Checking Accounts

The Operating Cycle

The operating cycle can be defined as the system through which cash flows, from the purchase of inventory through the collection of accounts receivable.

It measures the flow of assets into cash and is, in effect, a “business stopwatch.”

For example, the operating cycle may begin with both cash and inventory on hand.Additional inventory is purchased on account to work as a cushion for future sales to guarantee that you will not deplete your stock.Except for cash sales, when some of your inventory is sold, accounts receivable increase, but your cash doesn’t.Typically, you pay for the inventory you have purchased thirty days after it is received.When the payment for inventory is made, both cash and accounts payable are reduced.Thirty days after the sale of inventory, receivables are usually collected, which increases cash.Now your cash has completed its flow through the operating cycle and is ready to begin again.

Current Assets

Cash and other balance sheet items which convert into cash within twelve months are referred to as current assets.Typical current assets are:

  • Cash
  • Marketable Securities
  • Receivables
  • Pre-Paid Expenses

A Plan is Necessary

Cash-flow analysis shows whether your daily operations have generated enough cash to meet your obligations, and it shows how major outflows relate to major inflows.As a result, you can tell if inflows and outflows from your operation combine to result in a positive cash-flow from operations or in a net drain.Any significant changes over time will also appear.Understanding this will lead to better control of cash-flows and will allow adequate time to plan and prepare for the growth of your business.

It is best to have enough cash on hand each month to pay the cash obligations of the following month.A monthly cash-flow projection helps to project funds and compare actual figures to past months.It is important to project your monthly cash-flow to identify and eliminate deficiencies or surpluses in cash.When cash-flow deficiencies are found, business financial plans must be altered to provide more cash.When excess cash is revealed, it might indicate excessive borrowing or idle money that could be invested.The objective is to develop a plan which will provide a well-balanced cash flow.

Planning a Positive Cash Flow

To achieve a positive cash flow, you must have a sound plan.Cash reserves can be increased by:

  • Collection of receivables
  • Tightened credit requirements
  • Price of products
  • Loans
  • Increased sales

Collection of Receivables

Actively manage accounts receivable and quickly collect overdue accounts.Revenues are lost when a firm’s collection policies are not aggressive.The longer your customer’s balance remains unpaid, the less likely it is that you will receive full payment.

Tightened Credit Requirements

As credit and terms are tightened, more customers must pay cash for their purchases, thereby increasing the cash on hand and reducing the bad debt expense.

While tightening credit is helpful in the short run, it may not be advantageous in the long run. Looser credit allows more customers the opportunity to purchase your products or services.But, be certain that the increase in sales is greater than the increase in bad-debt expenses.

Pricing of Products

The primary goal of business is to make a profit.Many small businesses fail to do so because they do not know how to price their products or services.Pricing is the critical element in achieving a profit as well as in maintaining positive cash flow, and is a factor all firms can control.

Before setting your prices, you must understand your product’s market, distribution costs, and competition.Remember, the marketplace responds rapidly to technological advances and international competition.You must keep abreast of the factors that affect pricing and be ready to adjust.


Loans from various financial institutions are often necessary for covering short-term cash-flow problems.Revolving credit lines and equity loans are common types of credit used in this situation.

Increased Sales

Increased sales would appear to increase cash flow, but be careful.For many companies, a large portion of sales are purchased on credit.Therefore, when sales increase, accounts receivable increases, not cash.Collection of receivables is usually 30 days after the purchase date, and sales expenses are most often incurred befor e receivables are collected.When sales rise, inventory is depleted and must be replaced.Because receivables have not yet been collected, a substantial increase in sales can quickly deplete a firm’s cash reserves.Again, by using a computer, you can maintain this critical data, as well as speed the time required to consider the “what if” concept.

Other Helpful Tips

  • Cash Reserve.You should always keep enough cash, as an added cushion for security, on hand to cover expenses.But, it is unwise to keep more money on hand than is necessary to cover your obligations.Excess cash should be invested in an accessible, interest bearing, low-risk account, such as a savings account, short-term CD or T-bill.Keeping excess cash on hand reduces both the growth and the return on investment.
  • Projections.Good accounting records and projections are important tools for a small business.Qualified accountants are necessary to help keep your records accurate and current.However, you can reduce your accounting expenses by producing your own summary statistics and projections.
  • Using A Personal Computer.With a personal computer, your business can have the added advantage of quick cash-flow projections as well as many other useful financial planning tools. A good financial-management package and computer will enable you to review projected inflows and outflows of cash from month-to-month or year-to-year.By analyzing these projections you can see the fluctuations in cash flow and create management policies to avoid potential shortfalls.

There are numerous computer programs for making projections and keeping records and many advantages to having a personal computer for your business.Thecapabilities of modern computers are almost unlimited–they can aid in nearly every situation, from basic bookkeeping and “what if” analysis to inventory control or market demand projections.While a computer is not a specific requirement to success for a small business, it is a business tool which in the future will separate the competitive from themediocre.

How to Get More Information

SBA has a number of programs and services available.They include training and educational programs, advisory services, publications, financial programs, and contract assistance.

Our offices are located throughout the country.For the one nearest you consult the telephone directory under U.S. Government or call the Small Business Answer Desk at 1-800-U-ASK-SBA.A free copy of The Small Business Directory of publications may be requested from your local SBA office or the Answer Desk.

Other helpful sources include:

  • State Economic Development Agencies
  • Chambers of Commerce
  • Colleges and Universities
  • Public Libraries

All SBA programs are available to the public on a nondiscriminatory basis.