Business Unusual Series: #6 Understand your Cash Flow

It goes without saying that cash is vital during periods of economic downturn. Cash is the fuel that keeps the engine running, the lifeblood of the business.

For most businesses, net profit (or net income) is not equal to cash, nor does it reflect the cash position of the business. So it is vital for all business managers to know where cash has gone and to also know what are the core cash generating parts of their businesses. For business managers who have historically focused on revenue or profit, the monitoring of Cash Flow during the current period may require greater attention.

The Cash Flow analysis software in Fathom is useful for answering questions like:

• Q. Where has the cash gone?
• Q. Is the business generating cash or absorbing cash?
• Q. Is cash sourced from core operations, or sourced from other activities?
• Q: How do we reconcile revenue for the period, to our bank balance?

In last week’s post we explored how using cash flow trend charts can help to answer other cash related questions like: Are Cash flows diminishing? Are Cash flows sustainable or subject to fluctuations?

Cash Flow waterfall chart

Using the Cash Flow analysis waterfall chart it is easy to visualise the flow of funds through the business. Green represents cash coming in and red represents cash going out. The size of the bars are also proportional to the quantum. This can be very helpful for visual learners to understand. An example might be the size of interest repayments from a loan relative to operational costs and whether, as a result, refinancing should be sought.

Tip. Using video recording or conferencing tools can be an effective way to talk through the movement of cash, allowing your management team or clients to understand why the bank account balance is as it is.

Interpreting the waterfall

Similar to a Cash Flow statement, the waterfall chart is divided into three major sections which separate operating activities, investing activities, and financing activities. By focusing on the subtotals of each section, it is possible to discern more about the health and characteristics of the business.

For example, Operating Cash Flow reveals how much cash the business is generating from its primary business operations – typically sales of services and products. Wherever possible, it is important to ensure that the operational aspect of the business is cash flow positive. In the current circumstances, this is a difficult challenge for many businesses. Any cash flow deficit from business operations will have to be compensated using financing or investing activities, or by using cash reserves. Negative operating cash flows, period after period, may signal that eventually cash will become insufficient to cover expenses or other obligations.

Additionally, Free Cash Flow can indicate a lot about the management practices of the business. For example, activity in this section may reveal management’s appetite for the purchase or sale of assets. If the business is selling its assets, it could be an indication of a cash flow problem. Conversely, a reduction in capital expenditures may indicate that management is seeking to control costs by delaying the purchase or renewal of long-term assets. The purchase of new assets may indicate that the business is optimistic about its financial position and so is investing for future growth.

Ultimately, this chart shows you the Net Cash Flow generated from one period to another. A healthy Cash Flow statement will show more cash coming in through the sources of cash than going out. This is known as positive Net Cash Flow. This cash flow generated by the business, can then be used to either increase cash reserves or pay back debt.

This reconciliation is highlighted at the bottom of the waterfall chart and shown below. To maintain a negative Net Cash Flow you will require cash in the bank account or may consider taking on funding or potentially benefiting from Government grants or loans if available.

The Cash Flow Statement

Tip. In Fathom’s reporting and analysis, you can see a cashflow statement and view comparisons to budget or prior periods.

In a period of reduced trading, some of the key questions to consider when looking at the Cash Flow Statement to inform decision making would include:

1. Is everything as you expect? Are there expenses you weren’t aware you were incurring, be they professional body subscriptions for ex-employees or insurance costs for disposed assets?
2. Are there fixed costs which aren’t so fixed i.e. can you renegotiate agile work spaces contracts or are there leniencies provided by the government on tax payment terms?
3. Do assumptions in the budget need to be addressed? Do Director’s salaries or dividends need to be adjusted in the short-term? Do staff need to be furloughed in order to remain in businesses?

One final tip, if you are a small business owner/manager struggling to understand your cash flow – get in touch with an accountant or business advisor, as they can help you to navigate through the challenges of this time.

Log in to Fathom and use the Cash Flow Waterfall to visualise the flow of funds through your business. Not a Fathom subscriber? We offer a 14 day free trial, no credit card required.