On the other hand, poor cash flow management can lead to missed opportunities, increased stress and even business failure. Without a clear understanding of what it is and how it works, you may find yourself struggling to keep your doors open.

What Is Cash Flow?

Before diving into the details, it’s helpful to start with a basic cash flow definition. At its core, cash flow is simply the movement of funds in and out of your business. Positive cash flow means you have more money coming in than going out, while negative cash flow indicates your business is spending more than it’s earning.

If you’re working with a bookkeeper or CPA, you can find this information by reviewing your cash flow statement.

What Is a Cash Flow Statement? 

A cash flow statement is a financial report that summarizes the movement of cash and cash equivalents in and out of a company over a specific period, typically a month, quarter or year. It’s sometimes referred to as an income and expense report. Cash flow statements cover three primary areas: operating activities, investing activities and financing activities.

Cash Flow vs. Profit and Loss

The terms cash flow and profit and loss are often confused. However, they represent different aspects of a company’s financial health. 

Cash flow determines a business’s ability to pay its bills, invest in growth opportunities and maintain a healthy financial position. Alternatively, profit and loss indicates whether a business is generating enough revenue to cover its costs and create value for shareholders. Profits are defined as the amount a business earns after deducting expenses from revenue. This key measure of a company’s overall financial performance is typically reported on your income statement, also known as a profit and loss (P&L) statement. 

It’s possible for a company to be profitable on paper but still experience cash flow problems. For example, this may occur if they have trouble collecting payments from customers or have significant outstanding debts. Conversely, a company can have positive cash flow but report a net loss if they have high non-cash expenses like depreciation and amortization.

Factors That Affect Cash Flow

A wide range of factors can impact a company’s cash flow, both positively and negatively. Common examples include:

• Sales volume and pricing
• Operating expenses
• Inventory management
• Payment and collections
• Economic conditions
• Seasonality
• Unexpected expenses
• Debt payments

Regularly monitoring your company’s financial performance, maintaining a cash reserve and having contingency plans in place can help mitigate cash flow challenges.

How to Analyze Cash Flow

Analyzing cash flow begins with reviewing your cash flow statement and other financial reports. Next, you’ll need to evaluate key ratios and interpret their meaning.

Key Financial Ratios

The following ratios provide valuable insights into your company’s liquidity, efficiency and overall performance.

1. Free Cash Flow (FCF)

Free cash flow is the cash that remains after subtracting capital expenditures from net operating cash flow. It shows the money your business has available for expanding operations, returning value to shareholders or paying off debt. To calculate free cash flow, use this formula: 

FCF = Net Operating Cash Flow  ̶ Capital Expenditures

Strong free cash flow is a positive indicator. It shows that your business has the flexibility to pay off debt, distribute dividends or reinvest in growth opportunities.

2. Operating Cash Flow

Operating cash flow represents the cash generated by your business’s primary operating activities. It excludes cash flows from investing and financing activities. A positive operating cash flow margin demonstrates that your business can effectively convert sales into cash. This is a sign of profitability and earnings quality.

3. Cash Flow to Net Income Ratio

This ratio compares your business’s net cash flow to its net income. An ideal ratio is at least 1:1, indicating that your company is efficiently converting income into cash. Calculate this ratio using the formula: 

Cash Flow to Net Income Ratio = Net Cash Flow / Net Income

4. Current Liability Coverage Ratio

The current liability coverage ratio measures your business’s ability to pay off its current liabilities using cash flow from operations. Similar to Cash Flow to Net Income, a ratio of 1:1 or greater is ideal. Calculate the Current Liability Coverage Ratio using this formula: 

Current Liability Coverage Ratio = Operating Cash Flow / Current Liabilities

5. Fixed Charge Coverage Ratio

The fixed charge coverage ratio (FCCR) evaluates the availability of incoming cash flow to support fixed charge obligations. The numerator, specific adjustments to cash flow, and the denominator, fixed charges, vary by agreement.

For instance, adjustments to cash flow can include rents and leases, distributions, and unfinanced capital expenditures. Adjustments to fixed charges, meanwhile, could include debt repayment, rents, leases and distributions.

An FCCR equal to 2 means the company can pay for its fixed charges two times over.
An FCCR equal to 1 means the company is just able to pay for its annual fixed charges.

FCCR is different from DSCR (debt service coverage ratio), but lenders and analysts use both in similar ways to understand a company’s financial health. Both ratios measure how well a company can generate operating profit to service its fixed obligations.

Interpreting Cash Flow Analysis Results

After reviewing your ratios, consider the following outcomes.

Positive Cash Flow

Consistently positive cash flow indicates that your business is financially healthy and capable of sustaining growth. However, be cautious if your investing cash flow is positive while your operating cash flow is negative, as this may suggest that you’re relying on investment sales to cover operating expenses.

Negative Cash Flow

Negative cash flow doesn’t always signify financial distress. For example, a negative investing cash flow could indicate that your business is investing in assets that will improve operations and product offerings.

Using Financial Products to Offset Cash Flow Fluctuations

Managing cash flow fluctuations is a common challenge for businesses, but using the right financial products can help smooth out the bumps. Here are some ways financial tools and services can support your business’s cash flow needs:

Payment and Collection Tools

Services such as Positive Pay, ACH payments or direct debit can streamline collections and disbursements, improving cash flow efficiency. Solutions like Lockbox Services accelerate the collection and processing of payments, helping you get paid faster. Remote Deposit Capture allows you to deposit checks electronically without a trip to the bank, ensuring that funds become available more quickly.

Access to Short-Term Credit

Unexpected expenses or periods of negative cash flow can be mitigated through lines of credit (LOCs). These provide businesses with flexible access to funds to cover short-term working capital or emergency needs, allowing them to maintain smoother cash flow during turbulent times.

Investment Tools for Surplus Cash

During periods of strong positive cash flow, businesses can take advantage of sweep accounts, which automatically transfer excess funds into higher-yielding investment accounts. This ensures idle cash doesn’t sit unproductive and instead generates interest. Similarly, money market funds offer liquidity while also earning interest, making them an excellent tool for maintaining a healthy cash reserve.

Hedging Products for Economic Volatility

In a volatile economic environment, businesses may use hedging products to protect against risks such as currency fluctuations, interest rate changes or commodity price shifts. These tools help businesses stabilize cash flow even when external conditions are unstable.

Financing Large Capital Expenditures

For businesses that need to make significant investments in equipment or other capital expenditures, term loans can provide the necessary funds while preserving day-to-day cash flow. This allows for large purchases without causing immediate cash flow strain.

Empower Your Business with Cash Flow Insights

Understanding your company’s cash flow can significantly impact the success of your business. Regularly monitoring cash flow statements, calculating key ratios and interpreting results beyond face value will allow you to make informed decisions and maintain a healthy financial position.  

Banc of California’s experienced commercial and business banking team provides business customers with tailored financial solutions, strategic insight and support to help optimize cash flow, seize growth opportunities and mitigate risks. Reach out today to learn more.

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