Cash flow analysis is a way to study how your company’s cash flows in and out of the business. The purpose of this analysis is to identify opportunities where you can increase cash flow by collecting current receivables, selling inventory or paying off loans. Cash flow analysis consultants often describe it as a way of measuring the cash coming into and going out of a certain business. The final aim is to predict the ongoing cash-flow status, especially when it becomes necessary to meet financial obligations. The basic formula for calculating monthly cash flows would be starting with the beginning balance, minus any new sales that happened during that month, subtracting any payments for inventory or debt, and then adding in any new purchases or investments. Repeat this process for each subsequent month until you get to the end of your budget. You can also take into account all payments in a certain category such as insurance or interest on debt or taxes. The information you get will include the results of some calculations that give you the cash inflows and outflows for your business.
Advantages of cash flow analysis
The advantages are that it is easy to calculate and gives a good picture of income and expenses that can be compared with previous months, and helps determine if there are improvements to be made in how your business operates. The disadvantage, however, is that it is easy to make mistakes or skip over certain items which could lead to inaccurate figures. Also, the calculations can get complicated, and the results need to be interpreted carefully.
Cash flow analysis is helpful in getting a more accurate picture of your business. It also gives you a good idea of where your business is financially, gauging your ability to meet financial obligations and making decisions about investments. Cash flow analysis may be used for debt management purposes. For instance, cash flow analysis can help you determine whether loans are being repaid in full and on time, if you are still in debt, or if there is anything left over after paying off the debts.
If you are running a business, it will be necessary to go through the cash-flow assessment process at least once a year. It is helpful to compare final figures with the numbers used in last year’s cash flow report. In addition, these reports can help you with your decisions on new investments or other changes that can benefit your business.
Businesses with seasonal and irregular sales will probably have to go through this process more frequently because they may not be able to produce detailed monthly financial information for several months after the end of each month of the current year. Branches and subsidiaries primarily dealing in derivatives can also use cash flow analysis as a means of assessment due to their short-term nature.
Cash flow analysis may also be used in determining cash ratios for a business entity. Cash flow analysis is an important part of the estimation of liability underfunding, which is an important determinant in any plan for funding a pension for an entity.
Types of Cash Flow
The various types of cash flows can be classified into several categories and according to the time period from which they originate:
- Pension contributions: These contributions are shown on the records as debits. There are certain circumstances wherein these contributions are offset by the related investment earnings during that period. If this occurrence happens, then the net effect will be classified as a credit rather than a debit.
- Investment earnings: These are the cash flows contributed by employees to their retirement plans as a result of their contributions to the employer’s plan. To determine the amount of net investment earnings, we need to subtract from it the investment costs. This amount is then classified as either a debit or credit depending on whether or not any investments were discontinued during that period.
- Payments on obligations: This type of cash flow arises when remittances are made on behalf of the paid-up members of the pension plan, usually in relation to payments for medical insurance, annuities and other medical services. The payments for medical insurance and other medical services may be purchases or reimbursements as well.
- Loans and borrowings: These are the cash flows that arise from the loans taken out by the plan members to finance their medical insurance, annuities, etc., and also from the borrowings on which interest is paid. The charge for borrowed funds is shown as a debit to this category.
- Dividends: Dividends are paid out to plan members in relation to their holdings of shares in the pension plan. Classification of dividends as a debit or credit depends on whether any dividends were paid during that period.
- Other cash flows: This type of cash flow arises when lump sum distributions are made to the members of a pension plan in relation to the death of plan members, and if any other item are paid out. Classification of these transactions is similar to that for dividends.
Any change in one category necessitates a corresponding change in another category as well. For instance, if an employee dies and all his/her contributions have been paid into the employer’s plan, that would necessitate a change from a credit (because there will be no accumulation and investment earnings) to a debit (because there will be no more contributions).
Cash flow analysis can be used for other purposes apart from assessment of liabilities for underfunding. It may also be used in determining the amount of assets which can be funded if certain future obligations are met.
Of course, cash flow analysis is only as useful as the data available. If there are inaccuracies or omissions in information, it will not completely reflect how the business is performing and what its financial position is. The more reliable the data you get, the more accurate your cash flow analysis report will be.
Loan applications should be completed accurately to avoid misunderstandings and miscommunication between departments which can put everyone at risk. Loan applications should not contain false information, even if you do not directly fill out the application yourself.
