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There’s a Hole in My Bucket

Many businesses are so intent on looking at the level of water in their bucket (cash on hand) that they forget about flow. And there are two types of flow – in and out.

Looking at how cash is coming into the business can drive efficiency. Looking at how cash is leaving the business can be a revelation. What if there’s a hole in your cash bucket and putting measures in place can quell or stop the outflows?

Cash flow is distinct from Cash position. Having cash on hand is critical, but cash flow indicates an ongoing ability to generate and use cash. Many businesses often think of cash flow as the amount of cash in the bank. However, it may serve better to see cash flow in more dynamic terms. It refers to the movement of money through a business.

Cash flow is the net amount of cash that a business receives and disburses during a period. A positive level of cash flow must be maintained for a business to continue to operate. The period over which cash flow is tracked is usually a standard reporting period, such as a month, quarter, or year.

Finance professionals look at cash flow numbers as an indication of performance. Cash flow analysis reveals any patterns or trends that can help address deficiencies or expand on strengths within a client’s business.

Cash Flow Statement

There are three cash flow areas to track and analyse to determine the liquidity and solvency of a business. Cash flows are classified as operating, investing, or financing activities on the statement of cash flows, depending on the nature of the transaction:

  • Operating activities include cash activities related to net income. For example, cash generated from the sale of goods (revenue) and cash paid for merchandise (expense) are operating activities because revenues and expenses are included in net income.

  • Investing activities include cash activities related to non-current assets. Non-current assets include (1) long-term investments; (2) property, plant, and equipment; and (3) the principal amount of loans made to other entities. For example, cash generated from the sale of land, and cash paid for an investment in another company are included in this category. (Note that interest received from loans is included in operating activities).

  • Financing activities include cash activities related to non-current liabilities and owners’ equity. Non-current liabilities and owners’ equity items include (1) the principal amount of long-term debt, (2) stock sales and repurchases, and (3) dividend payments. (Note that interest paid on long-term debt is included in operating activities).

By examining the cash flow statement, it is possible to determine ways to remedy any shortfall by cutting costs and/or increasing income.

Cash Flow Analysis

Cash flow analysis determines a company’s working capital. It might not sound as glamorous as profit, and you may not talk about working capital every day, however, it’s the money a business requires to meet day-to-day expenses and seize growth opportunities. And it may well hold the key to your SME clients’ success!

Cash flow analysis refers to the examination or analysis of the different inflows of cash to a business and the outflow of the cash from the business during the period under consideration from operating, investing, and financing activities.

A cash flow statement analysis of working capital reveals the liquidity of the business.

How Cash Flow is Calculated

One method used to calculate the operating section is called the direct method (cash accounting method), which is based on the transactional information that impacted cash during the period.

The other way to prepare the operating section of the statement of cash flows is called the indirect method. This method depends on the accrual accounting method in which the accountant records revenues and expenses at times other than when cash was paid or received.

Cash Flow Metrics

Cash flow ratios compare cash flows to other elements of an entity’s financial statements. A higher level of cash flow indicates a better ability to withstand declines in operating performance, as well as a better ability to pay dividends to investors. They are an essential element of any analysis that seeks to understand the liquidity of a business.

Three common cash flow measures used to evaluate businesses are:

Operating Cash Flow Ratio

The operating cash flow ratio is cash provided by operating activities divided by current liabilities. This ratio measures the business’ ability to generate enough cash from daily operations, over a year, to cover current obligations.

Capital Expenditure Ratio

The capital expenditure ratio is cash provided by operating activities divided by capital expenditures. This ratio measures the business’ ability to generate enough cash from daily operations to cover capital expenditures.

Free Cash Flow

Free cash flow is cash provided by operating activities minus capital expenditures. The idea is that companies must continue to invest in fixed assets to remain competitive.

Interpreting a Cash Flow Statement

Financial documents are designed to provide insight into the financial health and status of a business.

Cash flow statements can reveal what phase a business is in: whether it’s a rapidly growing start-up or a mature and profitable company. It can also reveal whether a business is going through transition or is in a state of decline.

Working capital is critical to the long-term success of every business and managing working capital is an ongoing challenge for all businesses.

Particularly challenging during:

· their start-up and growth phases;

· the impact of unforeseen market changes; or

· the unexpected (e.g., COVID-19)

Cash flow is typically depicted as being positive (the business is taking in more cash than it’s expending) or negative (the business is spending more cash than it’s receiving).

Positive cash flow indicates that a company has more money flowing into the business than out of it over a specified period. This is an ideal situation to be in because having an excess of cash allows the company to reinvest in itself and its shareholders, settle debt payments, and find new ways to grow the business.

Positive cash flow does not necessarily translate to profit, however. A business can be profitable without being cash flow-positive, and a business can have positive cash flow without actually making a profit.

Negative cash flow means that cash outflow is higher than cash inflow during a period, but it doesn’t necessarily mean profit is lost. Instead, negative cash flow may be caused by expenditure and income mismatch, which should be addressed as soon as possible.

Negative cash flow may also be caused by a company’s decision to expand the business and invest in future growth, so it’s important to analyse changes in cash flow from one period to another, which can indicate how a company is performing overall.

Importance of the Cash Flow Statement

The cash flow statement is the financial statement that presents the cash inflows and cash outflows of a business during a given period. It is equally as important as the income statement and balance sheet for cash flow analysis.

Without a cash flow statement, it may be difficult to see cash flow issues or have an accurate picture of a company’s performance. The income statement will show financing activities like how much interest was paid on a loan as well as recording sales and profits, and the balance sheet will reveal how much the business owes, however, only the cash flow statement will detail how much cash was consumed servicing that loan, or alert one if those sales aren’t generating enough cash to cover expenses.

Cash flow statements provide invaluable information about cash flows across an entire organisation's operations. This information provides the basis for vital analysis that can impact net income, net cash flow, sales revenue, and ongoing operations.


Consistent cash flow is the lifeblood of a business. It is how an organisation can purchase stock, hire and train staff, diversify and ultimately expand its operations.

But what happens when this lifeline is interrupted?

It is a question and a challenge that many businesses face. Limited or unreliable cash flows can paralyse a business, stalling growth and forcing an operation into debt or even closure. With the economic climate being what it is, businesses simply cannot afford to allow operations to slow. One of the main reasons this can happen is due to outstanding invoices.

Businesses should think about future payment strategies to help avoid cash flow problems. As well as ensuring prompt payment by debtors, businesses also need to think about their outgoing payments. Not all payments can be deferred, however, taking full advantage of any delayed payment terms offered, can help.

Having the right people, practices and technology in place will greatly increase the chances of success. As will:

  • implementing a standard set of business payment terms

  • being upfront with customers about payment terms

  • automation to ensure your clients never pay an invoice early again.

Fluctuations in sales, competition, and ever-rising business expenses can all harm business cash flow. And slow payments can at times leave a business with no cash on hand to run it.

Ultimately, businesses need to find a sustainable solution – or risk becoming cash flow statistics.

Cash Flow Analysis is part of the Cash Flow Financing module in the Business Finance Certification, a professional development program that helps position you as an SME Finance specialist, so you can help your clients succeed and prosper. For more information go to:


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